FIRE Dissected : Financial Independence Vs Retiring Early
A major financial aspiration which is quickly catching on and evolving into a trend among youngsters across the world is FIRE (Financially Independent, Retired Early). In other words, FIRE refers to a situation where an individual has built their net worth to a point where it is enough to sustain them and their lifestyles for as long as they are expected to live. And by extension of this fact, it means that they no longer have to depend on their day jobs, thereby allowing them to retire early and gain greater control over their time. But there is a lot more to FIRE than just this. In fact, most of us lack a proper understanding of the terms financial freedom, financial independence and early retirement. Therefore, in today’s post I’m going to dissect and break down each of these terms. I will then show how we can go about planning for each of these goals. I will also offer my opinion on whether FIRE is a goal worth achieving.
Financial independence and financial freedom are two terms that are often used interchangeably. Therefore, most of us develop the perception that both terms mean the same thing. But in actuality, the meanings of these two terms differ significantly. Financial independence refers to a situation where an individual's networth is enough to sustain their lifestyles for the rest of their expected lifetimes, after accounting for the expected effects of inflation. Financial freedom on the other hand represents a situation where an individual has amassed a networth sufficient to sustain their lifestyles for a limited period of time on an inflation adjusted basis. Financial independence therefore encompasses financial freedom. In other words someone who has achieved financial independence is also financially free, but someone who is financially financial free may not necessarily be financially independent in the true sense. The planning and effort required to achieve financial independence is naturally a lot higher as compared to the effort required to achieve financial freedom.
Let us now understand the second half of the acronym FIRE, namely Retired Early which represents early retirement. In today’s times, retirement should no longer be viewed as cessation of gainful employment once one crosses a certain age threshold. Such a view would be too simplistic. Instead retirement should be viewed as a threshold in terms of networth, beyond which our dependence on earned income via gainful employment would reduce. And this would automatically give us the option to give up our jobs and retire. The exact figure of the networth threshold that would allow us to retire would differ based on the nuances of our individual situations. Some of us may achieve this networth threshold limit a lot quicker than others. Also, any extended period of time where we don't receive an income may also be considered as a mini retirement. An example of this would be say, being unemployed for a few months or taking a sabbatical for a few years. Retirement in today's times therefore has very little to do with our age. In fact, some of us who do build up enough networth and retire early end up feeling bored and unfulfilled in retirement. Also, there would be the additional challenge of ensuring that our networth lasts us for the entirety of our post retirement lifetimes (as shown in the graphic that follows).
Therefore, the option to retire early should ideally be exercised only when we have a clear plan regarding what we would like to do to manage our money and our time in the years post retirement.
Let us now understand how we can go about planning to achieve either of financial independence, financial freedom or FIRE. The first thing we need to come up with is a threshold figure that will set an end point for our chosen goal. One common demand posed by all three of these goals is the requirement of a healthy savings rate (anywhere between 15-30% or more of our monthly income). It would also help if we could increase our savings rate by at least 10% a year, if not more. Those of us who find it hard to save such amounts with our current levels of income may explore options to raise our income or create multiple streams of income. If we wish to plan for financial freedom, our savings rate must be at least 20-30% of our monthly income. Also our savings must be invested with a fairly conservative asset allocation (say 70% debt 30% equity). This is because the goal of financial freedom (a short sabbatical) would fall due a lot quicker than financial independence. Also the money we save up would pay for our expenses during our sabbatical. Therefore we cannot afford too many risks with it. If on the other hand we wish to plan for financial independence or FIRE, our savings rate can be relatively lower (15-30% of our monthly income). Our savings can be channelled through an asset allocation strategy that has slightly higher exposure to equity (say 60% equity 40% debt). This is because financial independence and FIRE are longer term goals by their very nature, thereby creating room for relatively higher risk to be taken. This is summed up in the graphic that follows.
As far as inflation is concerned, the very most we should assume is that our portfolios generate returns that are enough to allow our purchasing power to keep pace with inflation, but not beat it (technically called zero real returns). For a more realistic representation we may assume that we lose 1-2% in purchasing power to inflation every year (technically called negative real returns). As depressing as this may sound, this is exactly what happens in most real world cases, even with reasonably prudent money management. Therefore if we find that we cannot devote enough money to these goals based on such calculations, the unfortunate truth is that we would have to accept the fact that we cannot achieve our chosen goal.
I will end by offering my opinion on whether FIRE is a goal that is worth achieving. The FI portion of the acronym FIRE represents Financial Independence, which is the ultimate state of financial wellbeing for any individual. It is therefore a goal that every individual may strive to work towards. The RE portion of the FIRE acronym represents Retired Early or early retirement, which seems appealing but may not turn out to be as rewarding as advertised. Therefore a lot of thought needs to be exercised before the decision to retire early is acted upon. To my common sense, a possible solution would be to first achieve financial freedom as quickly as possible in our younger years and go on a sabbatical. The sabbatical would be ideal to simulate the post retirement lifestyle we may have envisioned in our heads. If we find our envisioned post retirement lifestyle to actually be fulfilling, we may continue to press on with our efforts to achieve FIRE. If not, we may simply aspire to achieve financial independence first (which gives us the power to retire at will) and retire later once we have a clear idea of what we would like to do with our lives post retirement. That way, FIRE would be something that lights up our lives without burning us out.