Welcome to Taking Stock, a space where we can take a deep breath and try to figure out what the COVID-19 economy really means for our finances. Every month, personal finance expert Paco de Leon will answer your most difficult, emotionally charged questions about money. This year has forced many of us to reprioritize our finances, and there’s no clear road map for getting through the pandemic yet — but Taking Stock is here to help us figure it out together.
This week, we’re talking about whether retiring early — like, by the time you’re 35 — is just a ridiculous fantasy, or actually within reach.
Dear Paco,
I’m fascinated by people who manage to retire in their 30s, or at least before 65. How on earth do regular people who don’t have huge inheritances actually gain enough financial security to retire so early? How does the math work out? Is this just a pipe dream for most of us, or am I focusing on the wrong goals by trying to hold down my traditional 9-to-5 job and a steady stream of barely enough paychecks? Sometimes I feel like I’ll be working into my 80s. What is your opinion of the F.I.R.E. movement, and how can I tell if it’s something I should pursue?
Dear Fascinated by F.I.R.E.,
The F.I.R.E. movement — which stands for Financially Independent/Retire Early — is a polarizing topic in the personal finance community. There are plenty of personal finance experts that love to hate it, while others are evangelical about their F.I.R.E. lifestyle. I view the growing popularity of the F.I.R.E. movement as a mostly good thing. I’m not a fanatic, but anything that gets people more engaged in their financial lives is a net positive.
The main idea behind it is that it’s possible for people to amass enough money to retire at a very young age if they follow a very aggressive savings and investing strategy. As long as their investments provide enough money for them to sustain themselves long-term, they can achieve financial independence.
The F.I.R.E. movement has become more popular in recent years as a seemingly direct reaction to how the path to financial stability has gotten narrower for many Americans, who are increasingly experiencing economic pressure due to the rising costs of education, housing, and healthcare. With decades of low wage growth and employment instability, many people are living in a constant state of financial precarity, and are looking at any available hacks to secure their futures.
So, is it feasible for you to escape this insecurity and manage to retire early? Let’s break down the numbers.
The Math Behind the Movement
A “normal” path to retirement is to work for 40 years, while saving and investing at least 10% of your income into a well-diversified portfolio that will return an average of 8% year-over-year. After a cool four decades of consistently investing, and with the magic of compounding returns, you’re left with a nest egg that will pay for your living expenses in retirement. But, if your goal is to retire early, then you have much less than 40 years to save and a much longer period of time that your nest egg will have to pay for. You’d have to save and invest a lot more than 10% of your income — like 50% of it, or even more.
The Rule of 25 — also known as the Multiply-by-25 Rule — is a quick way to calculate how much you’ll need to save for retirement. As the name suggests, you need an investment portfolio valued at 25 times your annual income to ensure that you never run out of money. So, if you earn $50,000 a year, according to The Rule of 25, you need to amass $1.25 million. Keep in mind that you don’t need to save $1.25 million — you get to that number by both saving and investing a huge portion of your income each month into a well-diversified portfolio that will return an average of 5 to 8% a year.
Let’s not forget: Compounding returns are truly magical! For example, say you invested $22,000 per year for 24 years, and earned a 7% annual return on investment. At the end of 24 years, you would have contributed $528,000 into your investment and earned $751,886, for a total of $1,279,886.
Once you’re retired, spend according to the 4% rule. The 4% rule is a framework used to determine how much can be spent each year without running out of money — 4% of $1.25 million is $50,000, the annual income you used to calculate how much you’d need to amass for retirement. There are folks in the F.I.R.E. community who suggest 3% is a safer withdrawal rate than 4%.
Why 4%, or even 3%, if your investments earn 5 to 8% each year? Because you need to account for inflation and market volatility, and give yourself a comfortable margin of safety.
Let’s Get Critical: Where There’s Smoke…
While I personally don’t have a strong opinion for or against F.I.R.E., there are things about the movement that you should consider critically when you’re trying to determine if it’s right for you.
It gives people a concrete goal, for better or worse. I appreciate F.I.R.E. principles because they simplify retirement goals. When you know that you need to save 20 to 25 times your income, you have a very clear goal. On the other hand, this goal can be overly simplistic, because you don’t know exactly how long you’ll be retired for, or whether or not your needs will change due to things like illness, for example. Which leads us to…
A plan can’t encompass all possible outcomes. There are a lot of unpredictable things that can happen over the years. On the more mild end of things, maybe right now, you never turn on the heater or air-conditioning, but that might become necessary for your comfort as you age.
More importantly, your healthcare costs could also drastically increase. You and your partner could split up, which will most certainly change your personal finances. The inevitably of our changing lives isn’t a reason not to strive for early retirement, but it is something to be aware of. When you make retirement projections, you’re making future plans based on what your current life looks like. Without realizing it, you might be planning for certain aspects of your life to remain static when, in all probability, they won’t.
You have to earn enough to save enough. The sacrifices that must be made in order to retire early are easier for some than others. One person might find great fulfillment in conserving money by riding a bike instead of driving a car. For another, such a trade-off might simply be impossible.
There’s one underlying assumption about retiring early: You have to earn enough money for it. Your income needs to cover your basic expenses, with enough left over to save and invest a large portion of it toward retirement. This is simply not feasible for everyone. No amount of being frugal can offset the fact that you don’t earn enough for the aggressive saving that early retirement requires.
Beyond the bottom line
Let’s look at some non-financial considerations in the early-retirement decision. What role does work play in your life today? What role do you want it to play? Do you find a sense of satisfaction, accomplishment, or connection from it? There aren’t any wrong answers — it’s more about understanding your relationship with work. Personally, I can see myself always “working,” even if that just means tinkering on different projects.
If you are trying to retire early, what happens after you reach that goal? Is your work tied to any feeling of purpose and progress for you, and have you thought about how you will feel when you no longer have work in your daily life?
What do you truly value in life, and is that being reflected in how you spend your money, your time and your energy right now?
So, is F.I.R.E. feasible for you?
It depends on what you earn, what you can save, and when and where you want to retire. It depends on what happens to you in your life and how you’re able to respond to what happens. It depends on the trade-offs and the sacrifices you must make today in the hopes that they will have been worth it in the future.
Even if you ultimately decide not to go full-on F.I.R.E., you can still take the principles and apply them to your life — maybe just less intensely. Instead of trying to amass $1.25 million in 22 years, you could work towards saving six-figures in a fraction of that time. It might not be enough for the rest of your life, but it’s enough to impact your financial well-being. Even if you don’t retire early, it could still be a life-changing amount of money that gives you some peace of mind.
Your financial friend,
Paco
Are you someone who’s managed to retire early, or on track to do so? Do you have strong opinions on the F.I.R.E. movement? Share your experiences with us here to be featured in an upcoming Refinery29 story.
Do you have a question or dilemma you’d like to see answered as part of Taking Stock? Submit it here or send us an email at moneyquestions@refinery29.com.
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