You’d think that personal finance gurus and pundits would embrace the FIRE movement (Financial Independence / Retire Early). The FIRE crowd preaches a debt-free lifestyle, healthy savings rates, smart low-fee investing, and life over money.
What’s not to love?
Yet it seems that some just can’t help hating on FIRE. They claim few can save the amounts of money needed to retire on time, let alone early. They complain about the return assumptions used in early retirement calculations. And they proclaim that a FIRE lifestyle is just plain boring. What’s the point of going without a latte for 25 years in the hopes of one day being financial independent?
In my new book, Retire Before Mom and Dad, I debunk these myths and offer a simple plan that most anybody can follow to achieve financial independence. In this article, let’s set the record straight by addressing five of the more pernicious myths.
Myth #1: You must save 50% or more to retire early
Those who claim early financial independence requires a savings rate of 50% or more haven’t done the math. Of course, the higher the percentage of income you save the sooner you’ll reach financial independence. Saving one-half of your paycheck, however, isn’t necessary.
Imagine a recent college graduate in her early twenties. She sets as her goal having 25 times her annual expenses in 30 years. By doing so, she’ll be financially free in her early 50s. What percentage of her income must she save to achieve this goal?
The answer depends on two really important assumptions. First, what will her after-inflation return on investments turn out to be over that time. Second, and this may surprise you, does her employer match her retirement contributions?
As to her returns, I use a 6.3% after-inflation return assumption in my book. We start with the returns of a portfolio consisting of 70% stock index funds and 30% bond index funds. Since 1926, such a portfolio has returned 9.3%, according to Vanguard. Then we subtract inflation, which has averaged just under 3% during the same time period.
(Some will argue that the past doesn’t guarantee the future. They are, of course, right. See Myth #4 below.)
With this assumption, our fearless Freedom Fighter would need to save between 20 and 25% of her income. A healthy savings rate, to be sure, but far below the dire claims of 50% or more. Add in a 401(k) match, and she will save another two to three years off the time it takes to retire
Myth #2: Early retirement means never working again
This canard just won’t die. It seems that many old people, like me, just won’t let go of our 1970’s view of retirement. Back then we worked until we were 65, and then we stopped working cold turkey. That’s not retirement today.
Those who have retired early that I know find work they love. It may not be full-time work. In many cases they start their own company. But they earn an income that takes pressure off of relying solely on their Freedom Fund.
Welcome to the 21st century.
Myth #3: FIRE is only for the young
This is arguably the most important myth to debunk. The concepts, strategies and tactics that enable some to retire in their 30s and 40s are desperately needed for those 50 or older with little retirement savings. Those in their 50s with no retirement savings will need to adopt the FIRE movement strategies just to retire “on time.” The good news is that there is a silver lining.
The FIRE movement defines financial independence as having 25x your annual expenses. For those who retire long before the age of 65, they must rely entirely on the money they have saved. For those retiring at a more traditional age, most have other sources of income, such as social security.
Let’s imagine a Freedom Fighter, as I like to call those in the FIRE crowd, needs $60,000 a year in retirement income. For those retiring early, they will need a Freedom Fund of at least $1.5 million ($60,000 x 25). For those new to FIRE math, this assumes that we can withdraw 4% of our nest egg in year one of retirement.
The math changes for those with social security and other retirement income. Imagine this same person gets $20,000 a year in social security, pension or other retirement income. Now they need a nest egg of $1 million ($40,000 x25). Still a lot of money, but a lot less than $1.5 million.
Myth #4: The next bear market will snuff out the FIRE movement
Many complain about the return assumptions used in FIRE calculations. In one recent article here on Forbes, the author argued that one should assume a 2.5% after-inflation return. He even called us lunatics. That’s bearish. But it misses the point.
First, we have no idea how stocks will perform tomorrow, let alone over the next 20 to 30 years while somebody pursues early retirement and financial independence. One can certainly argue that the S&P 500, as measured by the P/E ratio, is richly valued. It currently stands at over 21, while its median value is under 15. We can all also acknowledge that interest rates are at historic lows. As rates rise, the value of all assets, including stocks and bonds, will fall.
What is a Freedom Fighter to do? First, let’s remember that the P/E of your portfolio probably doesn’t match that of the S&P 500 (unless 100% of your money is in an S&P 500 index fund). The trailing P/E of my portfolio is about 16, and the forward P/E is under 15. Why? Because many of the asset classes I own, such as foreign companies, small companies, value stocks, and banks, have P/E ratios far below that of the S&P 500.
That’s not to say that my portfolio won’t fall in the next bear market. It surely will. And it may fall a lot. But predictions of portfolio returns based solely on the P/E of the S&P 500 index are of little value.
Second, for those in the accumulation phase of FIRE, a sustained bear market is your best friend. When stock prices fall, your investment contributions and dividend reinvestments buy more shares. In fact, Freedom Fighters everywhere should hope for a sustained bear market. You’ll reach your goal sooner.
Finally, the markets will return whatever the markets will return. We can’t control that. I’ve found that those who consistently predict gloom and doom are, much like a broken clock, right once or twice each decade. We control what we can (picking low cost investments, savings rate), and let the markets do what they do.
Myth #5: Early retirement requires saying no to lattes, forever
The latte factor has taken some heat lately. It turns out that millennials don’t like hearing multi-millionaire financial gurus telling them to avoid coffee. Who would have guessed?
Truth be told, I’ve yet to meet an early retiree who achieved FIRE by avoiding lattes. I have, however, met plenty who have achieved financial independence by avoiding mindless spending. And that may or may not include lattes.
Here’s a simple strategy. Decide on your savings rate first, and work hard to achieve that goal. Once you achieve your savings rate goal, spend the rest of your money however you want to. If that means buying lattes, go for it.
It’s why I say, ‘freedom first, lattes second.’