Financial independence, retire early – well, maybe not such a good idea
Have you heard about FIRE? That’s an acronym for “Financial independence, retire early.” It’s a movement that seems to have attracted the attention of many Millennials. (You’ll remember, that’s the group who started to come of age around the year 2000. In other words, the young working generation.)
Let me answer three questions: What? How? Why? And then (this is hardly a spoiler alert, as the title gives away my view) I’ll tell you why I’m not overly keen on it.
It’s an idea, a lifestyle idea, not formally organized. I understand that it was first mooted in the 1992 best-selling book Your Money or Your Life by Vicki Robin and Joe Dominguez. The idea is that you push yourself, while you’re working, to save far more than would normally be feasible. And the goal is then, as the name implies, to have sufficient assets to make yourself financially independent of the need for further work; indeed, to enable yourself to retire early – far earlier than anyone thinks is normally feasible. (Like, in your 30s.) And remember, when you retire that early, there’s no government program that kicks in for a long, long time, so it truly is self-made independence.
Once you’re retired early, you draw down your accumulated assets to support yourself.
That’s the basic idea.
You save a lot! There’s no formal amount, but it seems that, if you’re serious, you save at least 50% of your net (after-tax) income, and if you can get up to 75%, so much the better.
There are two obvious comments. One is that you need to be earning a fair amount if you have to live on only 25-50% of it, so it’s not for the low-paid. But it seems that this is far from being an upper-class movement. Most of its adherents seem to be bang in the middle class, so the other obvious comment is that they’re making a huge lifestyle sacrifice to achieve their goal. It’s not surprising, therefore, that many adherents have one or more side jobs to enable them to live (even if it’s a frugal lifestyle) while saving that intensely. (But hey, it’s a gig economy, right? So maybe that simply makes a virtue out of necessity.)
They believe they achieve independence when their assets amount to 25 times their annual living expenses. Why 25 times? That comes from the famous “4% rule,” which they interpret as saying that you can sustain your lifestyle indefinitely if each year you draw down 4% of the initial amount of your accumulated assets.
I haven’t seen anything explicit on investments, but I’ve seen references (that make a lot of sense) to using passive (index) funds, preferably those investing around the world, not just in the home country.
Again, two aspects come to mind. One is that, if you’re seeking long-term growth, it is sensible to spread your bets and invest globally, rather than taking the chance that betting solely on your home country is best. The other is that active investment management fees, over the long term, consume a huge amount of wealth, and that’s surely very important to FIRE adherents: if you’re going to starve yourself, why feed an active manager instead? (For more detail about the impact of fees, see Walk 22 “Your first conversation with a financial professional” in Life Two, and use the online calculator called T-REX, for Total Return Efficiency Index http://larrybates.ca/t-rex-score/, developed by author Larry Bates in connection with his book Beat the Bank.)
Finally, to complete the overview: Why?
That’s a tough question to answer. When you’re trying to explain why someone else does something, it’s extraordinarily difficult to get into their mind. At best you can guess. Or if you’re lucky they explain what they’re thinking. But it’s tough to generalize, because it’s often the case that different people do the same thing for entirely different reasons.
That said, here are some of the answers I’ve uncovered.
The first is simply negative. It has nothing to do with retiring early. And that seems to be the case with the majority that I’ve read about (admittedly, a tiny sample). It has everything to do with financial independence, which in turn then gives the doer a sense of control: “Now I can do anything I want.”
Some seem to have at least a vague idea of what they want to do, like starting a new business. Or giving themselves a choice of jobs that they hope they’ll find satisfying. Or indulging in travel that’s been a dream for a long time. In other words, the goal is control rather than retirement.
For others it may be self-esteem, perhaps even braggadocio: “Look what I can do, see how excellent I am!” It’s the image they wish to convey to the world, rather than what it achieves for themselves.
It’s interesting that the acronym FIRE says nothing about what it means to retire early.
OK, after all that background, here’s my take on aspects of the FIRE movement. And I’m going to divide it into two parts: FI or “financial independence,” and RE or “retire early.” That’s because I think there isn’t a necessary connection between them.
I think the idea of financial independence is praiseworthy. We should all have it. Indeed we all strive for it, knowingly or unknowingly. I’ll bet there’s not one of us who thinks: “No, I don’t want to be financially independent.”
That doesn’t mean going crazy in pursuit of the goal. Is financial independence at 35 better than financial independence at, say, 55? That depends on what you plan to do with the additional years from 35 to 55. Certainly you have more choices, more control, if you’re FI at 35. But if it’s “Well, what do I do now?” – then the value vanishes.
So to me the key is having a vision about how you’ll use the “retire early” part of FIRE. And I don’t mean a financial vision. I mean having a purpose, an idea of what will give meaning to those many years ahead of you. If you have this vision, that’s wonderful. If you don’t, then FIRE is essentially a pointless goal.
Remember the three big retirement questions that Life Two deals with. Psychological: Will I lose my identity? Practical: How will I fill my time? Financial: Will I outlive my assets?
Of these, the first is unlikely to be a big problem, I’d guess, if you’ve achieved financial independence early. Your job is clearly not your identity – it’s just a means to the FIRE goal. But just because you don’t have your identity tied up in your job, it doesn’t mean you’ll automatically have a purpose, a way to live your life that brings fulfillment. In fact, for those for whom job equals identity, the big problem is how to find another sense of purpose, in retirement. And that’s an issue whether or not job equals identity.
It’s this lack of purpose that could be the biggest downside to not thinking through what FIRE success means to you. I don’t know if you remember a theme of Daniel Gilbert’s book Stumbling on Happiness. It’s that we’re not good at anticipating what will make us happy. And so it’s quite possible (in fact, more than likely) that a FIRE achiever will think: “I’ve done it. Is this all there is? Shouldn’t I feel better about having got here?”
It’s absolutely true that, if the first attempt doesn’t bring fulfillment, you’ll still have many more opportunities to search for something else, precisely because you’ve achieved financial independence. I’m just saying: be prepared for needing many strings to your bow.
Similarly with the second big question, about filling your time. Travel and golf probably won’t bring fulfillment if they’re the basis of the next 50 years. Having time available is wonderful when you’re short of it. But it can hang heavily if you don’t know what to do with it. Clearly this will be dependent on what you find fulfilling. The two will go together. Again, all I’m saying is: ponder this before you make FIRE a goal. Giving freedom to your future self is something most of us don’t do very well. Succeeding at a huge cost to your present self, and finding that your future self is ungrateful – that could hurt a lot.
The third question, the financial one, is the one that financial geeks examine the most. They point out, quite correctly, that the 4% rule has nothing to do with sustaining a long-term retirement under future economic conditions. It’s a completely misinterpreted extrapolation of a single analysis done by Bill Bengen in 1994. He had a very limited purpose. Looking backward, using a 60/40 equity/bond portfolio, and using an annual withdrawal of a fixed amount, what maximum percentage withdrawal would have lasted through 30 years? Answer: 4% of the initial amount. Look forward instead of backward (with, for example, dramatically lower interest rates), change the asset allocation, change the time period: the conclusion no longer applies when even one of these conditions changes, let alone when all of them change. In fact, over a 50-year horizon perhaps the most important financial characteristic you should espouse is adaptability! Conditions change, and you should be flexible enough to change with them. But that’s not discussed.
There’s another aspect I don’t see discussed, and that has to do with taxes. The general theme goes along the lines of: “I need to spend 40,000 a year, so I need 25 times that, or 1 million.” Wrong. If you withdraw 40,000 you’ll have to pay tax on it (in the vast majority of countries!), and it won’t support your desired spending. So even the flawed 4% rule isn’t applied correctly.
To sum up, in my view FIRE is likely to be a poorly-thought-through goal. Congratulations to those (the few, I’d guess) who have thought it through. And even then I’d wonder, for them: looking back, would you have preferred not to have done it in such an extreme way?
FI yes, RE no.
I have written about retirement planning before and some of that material also relates to topics or issues that are being discussed here. Where relevant I draw on material from three sources: The Retirement Plan Solution (co-authored with Bob Collie and Matt Smith, published by John Wiley & Sons, Inc., 2009), my foreword to Someday Rich (by Timothy Noonan and Matt Smith, also published by Wiley, 2012), and my occasional column The Art of Investment in the FT Money supplement of The Financial Times, published in the UK. I am grateful to the other authors and to The Financial Times for permission to use the material here.