For some, retirement may be decades away. For others, retirement and Social Security benefits seem like they’re just around the corner. However, the youngest members of society are often the ones who—despite being in the best position to prepare for it—haven’t even thought of retirement yet! Of course, blanket statements are never applicable to everyone. As it turns out, there are some younger people who’ve formulated an aggressive form of retirement planning. Introducing the FIRE method!
What is the FIRE Method?
FIRE is an acronym for “Financial Independence, Retire Early.” One could argue that it’s less of a methodology and more of a lifestyle, as it requires making significant changes to accomplish specific goals later on. While specific retirement goals vary from person to person, many FIRE followers aim to be able to retire by their 40s! This lofty goal may seem impossible at first glance, but with the proper budgeting, income, and adjustments, it can be done.
Of course, actually retiring is completely optional. Some may choose to follow the FIRE method using their full-time job, but still work after they’ve saved enough to retire. At this point, they’re considered “work optional”: they can still work if they’d like, but they’re not forced out of necessity.
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How It Works
At its core, the FIRE method relies on taking advantage of compound interest. Savings and
retirement accounts are great places to start, but many also take advantage of stocks & other investing opportunities. However, while many people may choose to invest, most of them aren’t able to retire by the time they’re 40. So, what’s the difference?
Well, the FIRE method favors saving for the future over enjoying the moment. That’s not to say one needs to live a lifestyle of abject poverty, but minimizing expenses is certainly key. Many proponents of the FIRE method invest 75% or more of their income! Saving such a high percentage certainly isn’t realistic for everyone, but you’ll need to save as much as reasonably possible without over-sacrificing your quality of life. Whereas the average person tends to live within or above their means, the FIRE method promotes living beneath your means temporarily to reach financial freedom sooner.
Sustainability & Calculations
Compound interest generates increasing revenue over time. Your investments will compound as you continue to work, but in order for the FIRE method to work, they must also continue to compound after you’ve stopped working. This is certainly possible, but it requires amassing enough wealth to live off of the interest alone. Once your annual interest income exceeds your annual spending, you’ve officially become “work-optional!”
There are a few different ways to calculate the amount of capital you’ll need to retire. 3% and 4% are commonly used as reference points, with the idea that your investments will return 3 or 4 percent each year. These returns will be your available budget for the year. Exactly how much money you’ll need to save depends on your anticipated annual expenses. Here are a few examples:
- If you wanted to live on $5,000 per month, your annual expenses would amount to $60,000. To calculate the amount you’d need to save to live on a 4% return, simply multiply the $60k by 25. Based on these numbers, you’d need to have a minimum of $1.5m saved to retire. To live off of a 3% return, you multiply the $60k by 33, which would indicate a required savings of $1.98m to live on the interest alone.
- However, retirement can come much sooner if you’re willing to lower your annual expenses. Let’s say you only anticipate spending $3,333 per month (approximately $40k per year). Based on a 4% return, you’d need to save $1m before you could live off interest alone. Living on a 3% return would require a minimum savings of $1.32m.
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Putting Things Into Perspective
These sums may seem like a lot, and that’s because they are: they’re enough to keep you financially stable for the rest of your life! While it’s certainly possible to reach these goals, whether it’s feasible by 40 really depends on your income. If you started with $0 at 18 and invested $1,695 every month with a return of 6.74 (S&P 500 historical average), you’d become a millionaire by 40. However, if you didn’t plan on retiring until 50, then you’d only need to set aside $768 per month!
It’s important to note that the applicable interest rate will have the biggest impact on your retirement timeline. While the historical return of the S&P 500 is 6.74%, the average return over the last decade is 16.4%. Based on that higher return rate, you’d only need to set aside $462 per month to break $1m by 40!
Planning for the Future
Realistically, the FIRE method isn’t for everyone. However, even if you don’t plan on using the FIRE method, that’s no reason to delay your retirement savings. As shown above, compound interest can be a valuable tool; all you need to do is take advantage of it! If you haven’t already, we highly recommend you start funding your retirement. Your future self is sure to thank you!