March 10, 2023 – After seven years of blogging in the personal finance and FIRE community, I realize that there’s one type of post I’ve always avoided: How to explain FIRE to a complete newbie. Until now, I’ve outsourced that task and simply referred to the Links Page. But where’s a good overview, all in a simple and comprehensive post to give a one-stop overview of what FIRE is and how one can pull it off? I’ve come across a lot of good information, but it’s all in bits and pieces and here and there. I’m not going to dump a reading/listening list of 20 different posts/shows on 18 different blogs/podcasts on someone new to the community. And my Safe Withdrawal Rate Series? Great stuff. But it’s also the deep end of the pool, and I would likely scare away any new recruits. That series is targeted at folks already retired or nearing early retirement.
So how would I explain or even pitch FIRE to someone new to the community? Let’s take a look…
Traditional vs. Early Retirement
Traditional retirement planning usually involves a 40 to 45-year accumulation phase. While not useful and applicable to all, the generic boilerplate retirement planning advice would normally involve saving around 10-15% of your net income. So, for every $100 you earn, you spend about $85-$90 and save and invest the remainder. Because the planning horizon is long enough to smooth out all the ups and downs of the economy and asset markets, those small regular contributions should be more than enough to build a sizable nest egg. The miracle of compounding! You will very likely close the gap between your expected Social Security benefits and your retirement spending needs.
So, together with Social Security and any other supplemental income from corporate pensions, you should be able to achieve a retirement income of $70 or more per $100 of pre-retirement income. Financial planners call that a 70% replacement ratio. Why only 70%? Well, first of all, in retirement, you need to no longer save for retirement, so you really only need to replace $85 of pre-retirement consumption. And the step down from $85 to $70 usually comes from lower expenditures: you no longer commute to work, no need for work lunches, etc.
FIRE requires you to step up your game and save a minimum of 30% or more of your net income. 50% would be even better. You can likely cut the accumulation phase in half and retire well before the typical retiree. You use your nest egg to bridge the time until Social Security starts and maybe even have a side gig, like a blog, or adjunct teaching job, etc., to supplement your budget for a few years.
How much do you have to sacrifice for that early retirement? It’s hard to put precise numbers into this chart because everybody’s experience is different, depending on how early you start, whether you first have to eliminate large debts, how aggressive your savings rate is, etc. But most FIRE fans should be able to retire well before the average American.
Absent a large inheritance, what all FIRE fans have in common is that we’d need to curb our consumption, which brings me to the next section…
The Power of Frugality
How can a shift in your savings rate have such a radical impact on your retirement timing? Very simple, every dollar of spending you redirect into investing helps you in two ways. First, you grow your nest egg faster, and second, every dollar you can permanently eliminate from your budget also reduces the nest egg target.
To observe these mechanics at work, let’s look at the following example. Imagine you currently save $15 out of your $100 income. For simplicity, I assume you want to “replace” the entire $85 of pre-retirement consumption rather than a reduced ~$70 retirement. If you use a rule-of-thumb of 25x annual expenses – the famous “4% Rule,” more on that later – you’d need a nest egg of $2,125 (=25x$85) upon retiring. Assuming a 5% real annualized return that task will take about 42 years, so just about in line with the boilerplate retirement advice. Cutting your expenses to $50 will not just accelerate your accumulation but also lower the nest egg target to “only” $1250 (=25x$50). In other words, by “attacking” your savings target from two sides – faster accumulation and lowering your retirement budget – you can reach your retirement target after only 16 years; see the chart below. Sweet! Reducing your spending by 42% ($50 vs. $85) will chop 62% off your accumulation time (16 vs. 42 years)!
What if you can’t manage a savings rate that high? Notice that FIRE is never an all-or-nothing proposition. If you can’t manage the customary 50% savings rate, start with a lower rate. And see how much earlier than planned you can retire, as in the table below. For example, simply going from 15% savings to 25% savings, you reduce the accumulation time by more than a decade. By the way, why would I include different savings multiples, 20x, 25x, and 30x? Very simple, there isn’t a one-size-fits-all solution in retirement planning. Some folks should probably target closer to a 30x, others a 20x savings target. But 25x is certainly a good start for most people. More on that below!
Of course, actual results may vary; asset returns can be better or worse and thus shorten or extend the accumulation phase, see my old post on the accumulation simulations with historical data. You might be able to accelerate your FIRE date if your net income grows faster than inflation. Or you could reduce your retirement budget by moving to a more affordable area, in what we call “Geographic Arbitrage.” And even without moving, people in the FIRE community are good at finding ways to save; my buddy Justin who writes at the Root of Good blog had a neat article on how a $40,000 annual retirement target really feels like a $100,000 budget for a working couple.
By the way, the table above also explains how some folks in the community took the express lane to FIRE; with a pretty hard-core frugal savings rate of 70%+, you can get there in under ten years, even with a modest 5% real return, and probably faster with the actual returns in the 2010s.
Of course, it’s one thing knowing that frugality can supercharge your path to retirement. But how does frugality look in practice? How can folks in the FIRE community save so much? That brings me to the next section…
Frugality in practice
For the majority of us, the most impactful savings effort will come from the three major categories:
- Housing: America’s favorite pastime is buying ever-larger houses. If you are the typical home buyer, you get an approval letter from the bank and go shopping to max out that budget. You are not looking for a house that you need or want but a house that the bank wants you to buy. A good way to start FIRE is to break this cycle and stop targeting or even exceeding the 28% payment-to-income ratio. My wife and I live in a comfortable 1,800-square-foot house in a nice neighborhood. Paid in cash with no mortgage. We could have spent a lot more on a McMansion, but our current house is really all we need.
- Vehicles: Another major money pit is buying and financing, or – even worse – leasing brand-new vehicles every two to three years. I know it looks great in your driveway, but if a mere 5 percentage point change in your savings rate knocks off years from your time to retirement, is that really worth it? Most people in the FIRE community recommend buying slightly used cars and driving them into the ground. There’s nothing wrong with buying a brand-new car either, as I did in 2019. As long as it’s a modest car and we plan to use it for an extended time. And later in retirement, when we have more certainty about our retirement withdrawal rate success, we may even splurge again and go for a nice brand-new ride made in Stuttgart or Munich.
- Food: While we still go out to restaurants occasionally, we prefer to cook at home most of the time. We don’t do takeout or delivery because we can fix something much healthier and tastier in less time for less money. Try to break the never-ending cycle of an empty fridge and overspending on takeout and delivery. The expense of any single takeout meal may seem small, but overspending small amounts daily will add up over the years. And might hold back your retirement by several years.
Beyond the three major categories, there will be additional savings potential with a smaller impact. Again, every single small spending “win” might not seem to have a large enough impact. But finding ten or twenty small savings hacks can.
But don’t go too far, either! This brings me to the next point…
But make sure you enjoy the ride!
I always thought that there was no point in going overboard with my frugality. We certainly still splurged on certain categories, like travel. It’s always best not to deprive yourself because the path to FIRE is not a sprint but rather a marathon. Or even more like an ultra-marathon lasting decades. Remember, everything you cut out from your budget to achieve that higher savings rate has to also stay out of your budget during retirement if you use that simple math displayed in the table above. Reward yourself and spend more on a few select categories that truly enhance your life. There is no need to forego the Avocado Toast or the Starbucks Coffee if that’s truly meaningful to you.
For example, while working in Atlanta and later in San Francisco, I splurged on eating out for lunch every day and getting my caffeine fix at Starbucks or Peet’s Coffee Shop with my office buddies. Maybe I could have cut my accumulation time by a few months if I had brought my lunch from home, but the social interaction with my colleagues over lunch and coffee was worth the price tag. Free education from some really smart people.
I also splurged on cars. I drove – gasp!!! – gas-guzzling, luxury 8-cylinder sedans back then. But I did so in the most cost-effective way, i.e., buy slightly used ones and drive them as long as I could. If you can be frugal without anyone else noticing it, you’re doing it right. See my post on Stealth Frugality from two years ago! For most people, it should be feasible to be frugal without looking cheap or stingy!
One of the greatest FIRE myths is that you have to be a finance wizard, stock picker, and expert market timer to reach early retirement. Not true. At least in the FIRE blogging community, finance professionals are only a small minority.
Most folks in the community reached their goal by simplifying their investing style. Passive investing with lost-cost equity index funds, like those offered by Fidelity, Schwab, and Vanguard, are all the rage. A broadly diversified large-cap index fund, replicating the S&P 500 (and its predecessor and historically reconstructed indexes), would have gained about 7.2% above the CPI index annually over the last one hundred years (12/1922 to 12/2022). Please see the chart below. That includes the Great Depression, WW2, crazy inflation during the 1970s and 80s, the dot-com crash of 2000-2003, the housing crash and global financial crisis in 2007-2009, and the pandemic bear market in 2020. And all the smaller ups and downs in between. So, that 5% real return assumption I used in the chart and table above was indeed quite conservative.
So, resist the temptation of stock picking. Also, resist the temptation of market timing. I know people who got out of the market in March 2020 when the S&P dropped below 2,500 points. And they are still waiting to see those lows again to get in again. It’s always best to automate your savings and investing and take the emotions out of it.
How about your asset allocation? Is it crazy to use 100% equities on the path to retirement? If you have the stomach for a lot of volatility, you can certainly use an all-equity portfolio. Risk-averse investors should probably consider moving to a more cautious allocation during the last 2-5 years. If you’re very risk-tolerant and/or very flexible in your retirement timing, you may even keep 100% equities all the way to retirement. See my post, “Pre-Retirement Glidepaths: How crazy is it to hold 100% equities until retirement?“
Another related issue: when investing, make sure you utilize all the tax advantages the government offers to you. That will vary from country to country, but if you’re in the U.S., check out the following:
- Contribute to your 401(k) plan to capture all the free money your employer gives you as a match. Sometimes a 1-for-1 matching of your contributions. You don’t get an instant 100% return anywhere else!
- In taxable accounts, buy-and-hold works best. Try to defer capital gains for as long as possible to avoid compounding a tax drag.
- Consider a Health Savings Account (HSA) as a quasi-retirement account with tax benefits even better than a 401k or Roth IRA, see a 2016 Wall Street Journal article. Instead of withdrawing money from the HSA for health care costs, keep the money in the HSA for extended tax-free growth, as outlined in this Investopedia article.
- Roth IRAs are neat, but not every investor is eligible due to income limits. But there are ways around the income constraint. One can always convert a regular IRA into a Roth IRA, regardless of income. This step also helps with another headache: how to access retirement plans penalty-free before age 59.5. Because Roth contributions and conversions can be accessed tax and penalty-free after five years, one could build a “ladder” of Roth conversions over five years before the planned retirement date and then access the conversion amounts from five years prior. The folks at ChooseFI have a nice summary of this technique.
- And many more. Check out a post of mine with more ideas: Principles of Retirement Tax-Planning – SWR Series Part 44.
Withdrawal Rate Basics
Where does this magical nest egg target of 25x your annual retirement budget come from? We base it on personal finance research dating back to the 1990s. Bill Bengen wrote a seminal paper in 1994, and three researchers at Trinity College in 1998 wrote a paper, often called the Trinity Study, pointing out that a diversified portfolio of stocks and bonds would have survived a 30-year retirement in most historical cohorts when withdrawing 4% of the portfolio in the initial year and then adjusting subsequent annual withdrawals for inflation.
If you’re still starting out on your FIRE path, years or even decades away from your FIRE date, you can probably safely target that 25x spending rule. My personal research has shown that certain idiosyncratic factors can significantly alter that target, though. If you plan for an extremely early exit from the labor market, say, in your 30s, it might be prudent to target a slightly higher savings target of about 30x to hedge against the risk of running out of money during your 50-year or longer retirement. In contrast, if you plan to retire in your 50s, you can likely get away with a smaller nest egg of maybe 20x if you expect substantial supplemental cash flows from Social Security and pensions after only a few years in retirement.
Once you get closer to retirement, though, it’s worthwhile devising a more detailed plan. What’s your retirement horizon? What kind of supplemental cash flows will you receive later in retirement? When and for how long? How much money do you like to leave to your heirs? And many more. Depending on your answers, you might get an initial safe withdrawal rate far above or far below the naive 4%.
Moreover, asset valuations will become more relevant when approaching your retirement date. Historically, the failures of the 4% Rule are always clustered around the cohorts that retire at the end of a long bull market that sent equity valuations (e.g., PE ratios, Shiller CAPE Ratio, etc.) sky-high. On the other hand, if you retire when equities are underpriced or only moderately priced, you can likely withdraw a bit more.
Some folks in the FIRE community, who probably don’t think too highly of my work, recommend just winging the safe withdrawal rate part. But most people reading my blog realize that performing a more customized analysis gives you the peace of mind needed before you leave the workforce. Think of early retirement as the largest “purchase” you will ever make, worth 10 or even 20 years’ worth of income lost (=opportunity cost). Several times larger than the typical home. Shouldn’t you put some thought into a “purchase” that large? Especially considering how much time people dedicate to much smaller purchases like a home or a car!
Of course, you will always encounter naysayers. Here are some of the objections I have often heard over the years, as well as my replies:
“Only very few people can do this in practice.”
The first objection is that to achieve FIRE you need to be a member of an elite club of Americans satisfying all of the following conditions: 1) college or graduate-school educated, 2) either single or a dual-income couple, 3) without children, 4) in a high-paying profession, and 5) living in a low-cost-of-living area. Maybe some folks in the FIRE community check all those boxes. I also grant you that if you’re a married couple with one income, no college degree, five children, and living in San Francisco or New York City, you might have a hard time saving 50% of your net income. But most of us in the FIRE community will check only some of the boxes. For example, I have Ph.D. in economics and worked in finance, a highly-compensated profession. But we have a daughter, my wife has been a stay-at-home mom, and we’ve always lived in expensive metro areas. We have a score of 2 out of 5 and still managed to save aggressively.
“You were just lucky.”
The second objection is that I just had fortunate timing. Specifically, people often lament that because today’s savers have a much leaner outlook on asset returns, they cannot possibly achieve FIRE anymore. But that’s not really true. The average annualized compound return in the S&P 500 total return index (including dividends) during my 18 years of accumulation from 8/31/2000 to 5/31/2018 was only 3.2% after inflation; please see the chart below. (Note: this is the point-to-point return, often called the “Time-Weighted Return,” independent of cash flows along the way. Essentially a buy-and-hold return)
In fact, for the first 12+ years, the S&P 500 was flat when adjusting for inflation. That said, there were also some great opportunities for picking up equity index funds along the way through the two bear markets. The money I invested at the market bottoms of 2003 and 2009 gave me an average annualized return of 7.9% and 16.1%, respectively. While saving for FIRE, you win some and you lose some. If you had invested $1,000 every month at the beginning of each month, adjusted for inflation, during the 213 months it took me to reach FIRE, you would have a total of just under $440,000. It’s an internal rate of return (a.k.a. the Money-Weighted Rate of Return) of about 7.6%. Slightly higher than the long-term historical average of real equity returns but by no means exceptional.
“FIRE bloggers aren’t really retired.”
The third objection is that all those FIRE bloggers are now busier than ever before. I’m certainly not, as blogging is mostly a hobby for me, and the little bit of advertising revenue accounts for only about 10% of my retirement budget. If you want to make serious money from blogging, you also have to make a serious time commitment, and the handful of folks who fall into that category probably do so. But keep in mind that the loudest voices in the FIRE community are also the profitable ones. There’s a selection bias in that you hear and read the most from busy and professional bloggers. But for every FIRE member with a financially successful blog, there ought to be thousands or more of just regular FIRE folks who simply retire and live off their savings. No blog and no other hustles are required if you plan right.
And just for the record, all of us bloggers and podcasters deserve every penny we may make for educating the community. If anything, we’re not making enough money.
“FIRE must be boring.”
And finally, the Hail Mary pass: FIRE will be boring for some people. There are indeed folks in the community that went back into the workforce a few years after retiring. But I’ve never felt a day of boredom in my almost 5 years of early retirement. We did an extended trip around the world in 2018 (7 months) and 2019 (4 months). We have a young daughter who keeps us busy, and we volunteer a lot of our time at various places – school, church, neighbors, etc. So, boredom and lack of purpose have never been a concern for us. But if you are worried, check out Fritz Gilbert’s blog, The Retirement Manifesto, and his book “Keys to a Successful Retirement” on how to plan for a purposeful and fulfilled retirement.
So much for today! It’s impossible to compress years of FIRE blogging into one single post. But I tried. If you’ve come to my blog for the first time and I piqued your interest, please subscribe to get an email notification if I publish a new post, maybe once or twice a month. I suggest you also check my fellow FIRE bloggers and podcasters listed on the Links page.
And if you’re getting closer to your FIRE date or just out of curiosity, make sure you check out my Safe Withdrawal Rate Series.
Thanks for stopping by today. I’m looking forward to your comments and suggestions below!
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