Financial independence retire early (FIRE) (Financial Independence, Retire Early) is a movement that involves saving aggressively and investing wisely to achieve financial independence. To understand the math behind FIRE, let's consider an example. Suppose you want to retire with an annual income of $40,000, and you expect to live for 30 years in retirement. Using the 4% rule (withdraw 4% of your portfolio per year, indexed to inflation), you would need a portfolio of $1,000,000 ($40,000 / 0.04). However, this rule is not set in stone, and many experts argue that it's too aggressive.
A more conservative approach might be to use the 25x rule (save 25 times your annual expenses), which would require saving $1,000,000 if your annual expenses are $40,000. To calculate this, you can use the following formula: Retirement Number = Annual Expenses x 25. For example, if your annual expenses are $40,000, your retirement number would be $1,000,000 ($40,000 x 25).
Understanding the 4% Rule and 25x Rule
The 4% rule and 25x rule are two common guidelines used to determine how much you can safely withdraw from your retirement portfolio each year. The 4% rule assumes that you will withdraw 4% of your portfolio each year, adjusted for inflation. The 25x rule, on the other hand, assumes that you will save 25 times your annual expenses. To illustrate the difference, let's consider an example:
- Annual expenses: $40,000
- Retirement portfolio: $1,000,000
- 4% rule: $40,000 (4% of $1,000,000) in the first year, adjusted for inflation in subsequent years
- 25x rule: $1,000,000 (25 x $40,000) needed to support annual expenses of $40,000
Common Misconceptions About FIRE
One common misconception about FIRE is that it requires being extremely frugal or earning a six-figure income. However, this is not the case. Anyone can achieve FIRE with the right plan and discipline. For example, suppose you earn $50,000 per year and want to retire in 15 years. To achieve this, you would need to save approximately $833 per month, assuming an average annual return of 7% and an inflation rate of 3%. Here's a breakdown of the calculation:
- Annual expenses: $40,000
- Retirement portfolio needed: $1,000,000 (25 x $40,000)
- Time to retirement: 15 years
- Monthly savings needed: $833 ($1,000,000 / 15 years x 12 months per year)
Getting Started with FIRE
If you're interested in achieving FIRE, the first step is to calculate your retirement number. You can use a tool like the Freedom Calculator to get an estimate of your retirement number based on your income, expenses, and savings rate. From there, you can create a plan to achieve your goal, whether that involves increasing your income, reducing your expenses, or investing more aggressively. For more information on how to calculate your retirement number, check out our guide on how to calculate your retirement number. Additionally, understanding the savings rate and years to retirement can help you make informed decisions about your financial plan.
First Three Steps to Achieving FIRE
The first three steps to achieving FIRE are to (1) calculate your retirement number, (2) create a budget and start tracking your expenses, and (3) start investing aggressively. For example, if you determine that you need to save $500,000 to achieve FIRE, you could start by investing $500 per month in a tax-advantaged retirement account, such as a 401(k) or IRA. You could also consider exploring lean FIRE vs fat FIRE vs barista FIRE to determine which approach is best for you.
Let's consider an example of how the first three steps might play out in practice. Suppose you earn $50,000 per year, and you want to retire in 15 years with an annual income of $40,000. Using the 25x rule, you would need a retirement portfolio of $1,000,000 ($40,000 x 25). To achieve this, you would need to save approximately $833 per month, assuming an average annual return of 7% and an inflation rate of 3%. Here's a breakdown of the calculation:
- Annual expenses: $40,000
- Retirement portfolio needed: $1,000,000 (25 x $40,000)
- Time to retirement: 15 years
- Monthly savings needed: $833 ($1,000,000 / 15 years x 12 months per year)
New to FIRE? See our primer at https://freedomcalc.app/what-is-fire.
By following the first three steps and creating a plan tailored to your individual circumstances, you can set yourself on the path to achieving financial independence and retiring early.
Tools worth looking at
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- Empower — Free net worth tracking, portfolio analysis, and retirement planner. The dashboard serious FIRE chasers actually use.
- Acorns — Round-ups that invest your spare change automatically. The lowest-friction way to start investing if you have been putting it off.
- Wealthfront — Tax-loss harvesting, a 5% cash account, and direct indexing once you cross $100k. Solid robo for the set-and-forget crowd.