Are you dreaming of achieving financial independence and retiring early? In this post, I’ll walk you through my complete FIRE (Financial Independence, Retire Early) guide, covering the key concepts, strategies, and tools you need to start your journey towards financial freedom.
For a quick answer to find out your FIRE number, scroll to the end of this post! Let’s dive in.
What is FIRE?
FIRE stands for “Financial Independence, Retire Early.” It’s a movement focused on saving and investing aggressively to achieve financial freedom at a younger age than traditional retirement. The goal is to accumulate enough wealth to live off the returns, allowing you to quit your day job and pursue your passions.
Simply put, financial independence is when you start making more from your investments than you spend annually. You no longer have to work to earn a living or worry about making rent payments on time.
You are free from having to work for a living.
The simple FIRE formula
The basic formula for FIRE is simple:
- Increase your income
- Decrease your expenses
- Invest the difference
By maximizing the gap between your income and expenses, you can allocate more money towards investments, accelerating your path to financial independence.
What are the different types of FIRE?
There are five different variations of the FIRE movement that dictate the lifestyle people can and are willing to live by:
1. Coast FIRE
Achieving a level of savings early in life that allows investments to grow without additional contributions, enabling individuals to work in less stressful jobs while their savings compound. Generally considered the easiest as it allows for a balanced approach to work and savings, without the pressure of aggressive saving later in life.
2. Barista FIRE
Involves retiring early but working part-time to cover some expenses, thus reducing the pressure on savings. Relatively easy to achieve as it combines early retirement with part-time work, allowing for a more comfortable lifestyle.
3. Lean FIRE
Focuses on extreme frugality and minimalism, allowing individuals to retire on a lower budget. More challenging than Coast and Barista FIRE due to the need for significant lifestyle changes and strict budgeting.
4. Standard FIRE
The classic approach requiring individuals to save aggressively (typically 50% or more of income) to build a substantial nest egg for retirement. Moderately challenging as it demands a high savings rate and disciplined investing, along with considerable lifestyle adjustments.
5. Fat FIRE
Aims for a more luxurious retirement, requiring a larger nest egg to maintain a comfortable lifestyle. The hardest to achieve due to the need for a high income and aggressive savings, along with the goal of maintaining a higher standard of living in retirement.
Understanding the 4% rule
In all our examples, we’re going to use the $1.8M goal based on the salary and living expenses of the average American. If you want to find a number more accurate to your individual situation, you will have to use the 4% rule.
Also known as the safe withdrawal rate, the 4% rule refers to the amount you should comfortably withdraw from your savings to cover your expenses every year after retirement without touching the principal.
Determining your safe withdrawal rate is the first step towards learning how to achieve financial independence. So, how do you determine how much money you should save?
- Determine your annual expenditure. It should cover any expenses you can spend in a year, including utilities, gas, groceries, rent, etc.
- Multiply it by 25 (years). The number may vary depending on how many years you plan on retiring.
- This should give you enough expenses to withdraw 4% for more than just a few years. For every $10,000 you spend a year, You should save $250,000 to achieve the financial independence goal.
Here’s a handy chart to show you how much you’ll need to save based on possible yearly expenses.
| Annual Expenses | Financial Independence Goal |
|---|---|
|
$20,000 |
$500,000 |
|
$30,000 |
$750,000 |
|
$40,000 |
$1,000,000 |
|
$50,000 |
$1,250,000 |
|
$60,000 |
$1,500,000 |
|
$70,000 |
$1,750,000 |
|
$80,000 |
$2,000,000 |
Using the above information coupled with your annual after-tax income, you’ll be able to come up with an annual savings rate (i.e., how much you need to save each year).
It would help if you always remember to factor in your yearly income, after-tax. You can also tweak the numbers until you reach a savings rate that you can comfortably handle. This should give you an idea of how much you should save every time you receive your paycheck.
In terms of percentage of income, your savings rate will vary based on your earnings and FIRE goals. Many FIRE members suggest that you should save an average of 50% of your total income to help you achieve your financial independence goals.
When subscribing to FIRE, you lock yourself into a similar lifestyle once you achieve your financial independence. Therefore, start embracing the lifestyle you want and use it as a basis for your financial independence target if you are making many economical choices.
This takes us back to our example: The average American needs to save about $1.8M if they want to retire early. In this case, the average savings rate will be around 32% of the yearly income every year.
Anyone that chooses to pursue financial independence needs to ask themselves whether they should try to live as frugally as possible in exchange for early retirement and keep their expenses low or whether they want a more refined lifestyle but to retire later.
…but you don’t have to take the same path as everyone else. How would it look if you designed a Rich Life on your own terms? Take our quiz and find out:
Strategies for achieving financial independence
Achieving financial independence through the FIRE is a challenging journey that demands hard work, discipline, and dedication. While the average person may need to save $1.8 million to reach their FIRE goal, the sense of freedom and satisfaction that comes with financial independence can make the effort worthwhile.
Here are some simple strategies for you to reach your retirement goals faster:
Note: FIRE may not be the right path for everyone. Individual financial situations, lifestyles, and long-term objectives vary, and some may find the sacrifices required to achieve FIRE too restrictive. Before pursuing FIRE, carefully consider your own circumstances and aspirations to determine if it aligns with your goals and values.
1. Earn more money
It will take you more than 26 years to save up to $1.8M if you earn a salary of $73,000 every year and save an average of 70% of your total income. That is too long and too aggressive for anyone that wants to retire early.
The good news is you can significantly shorten this time by earning more money. With more income, you can increase how much money you save and increase the rate at which you secure financial independence goals.
Although there are many different ways to earn more money, starting a side hustle is the most effective option.
2. Create a plan
It is almost impossible to achieve financial independence without a financial plan which allows you to save money and pay for what you love while staying on the path towards achieving your financial goals. Although everyone wants to gain financial independence and build wealth, we all have different financial plans.
You can create a reliable plan to help you achieve financial independence by knocking out your financial goals. Without goals, you will have a hard time reaching your financial success.
They enable you to understand what you want to achieve. Once you know your goals, create an emergency fund and clear any debts you have.
Also, make a plan to invest as it helps you build wealth which is a vital part of achieving financial independence. Your goal should also include a plan for retirement, taxes, estate, and insurance.
3. Have an emergency fund
Unanticipated financial expenses can significantly destroy your financial plans, especially when you don’t have the cash on hand to take care of them.
About 36% of the American population say they cannot comfortably take care of a $400 emergency in cash. You can run into anything such as loss of employment or a job layoff, or a long-term ailment that stops you from working.
Life could even throw a different financial challenge your way, and you will have a hard time making it through if you have to start from zero dollars in savings.
An emergency fund refers to money you put aside to take care of unexpected financial emergencies or expenses such as home repairs, unscheduled car repairs, unexpected medical bills, monthly expenses after a job loss, unexpected veterinary bills, and more.
You need to follow some rules when creating an emergency fund. Although financial experts recommend saving up to six months worth of living expenses in your emergency fund, you can start with a small amount and make your way up depending on your financial goals and needs.
Always consider the number of people in your household, how many of them have a source of income, the minimum amount you need to take care of monthly expenses, and the stability of your sources of revenue.
4. Invest in tax-advantaged accounts
You can minimize how much you pay in taxes and maximize the amount you retain through tax-advantaged accounts for your investments. With traditional investment or savings accounts, you pay taxes in the year you receive earnings.
On the other hand, tax-advantaged accounts allow you to decide when you pay taxes on contributions you make to the account and any profits you receive.
A tax-advantaged account is a form of financial account or savings plan that allows you to access different tax benefits. With a tax-advantaged account, you defer tax payments to a later date or qualify for exemption from paying taxes altogether.
There are two types of tax-advantaged accounts, including the pre-tax or tax-deferred investment accounts, which push your tax payments on any money you deposit into the account to a later date.
If you have an after-tax investment account, you deposit money on which you have already paid taxes. In this case, you do not have to pay taxes on any money you withdraw from the account.
The health savings account (HSA) is one of the best examples of a tax advantaged account. It offers an appealing option if you have health insurance plans with high deductibles. You can contribute pre-tax income to the account and later withdraw the money tax-free when used to pay qualified medical bills.
In simple terms, you’re able to set aside money to pay medical bills without having to pay any taxes on them. Other tax-advantaged accounts include Roth accounts, 529 plans, health flexible spending accounts (FSA), and more.
5. Diversify your investment portfolio
Diversifying your investment portfolio allows you to reduce risks by locating various investments across different industries, financial instruments, and other categories. With diversification, you do not put all your eggs in one basket.
It helps you maximize returns by channeling investments into different fields that react differently to a single event. If anything goes wrong with an investment in one field, you have the security of the others.
Diversification does not guarantee against loss, but it is essential to achieve your long-term financial goals with lower risks. To diversify your investments, you need to have different types.
Ramit advises people to invest in long-term, low-cost index funds that are diversified by nature and never require you to rebalance to maintain risk level
6. Cut costs
Most people sweat over the prospect of cutting costs. The thought of being unable to eat at your favorite restaurant or do something you enjoy often come up.
It doesn’t have to be the case. By cutting costs, you should focus on cutting costs mercilessly on things you don’t care about. Then if you still want to spend on a few things that really bring you joy, you can do so guilt-free. When you see a new car that you love, think about whether you want to get the car or if you want to work for a year less and still achieve your financial goals.
Cutting things that you don’t love or need gives you the idea that you are working towards achieving your financial freedom. It is what we call conscious spending.
It allows you to determine precisely how much you can afford to spend without having to worry about paying rent or covering other bills because it is already taken care of through automated payments.
However, if you want to achieve financial independence, you may wish to adjust the amount of money you save when implementing your plan.
7. Reevaluate your goal regularly
Once you have a financial goal and outline the financial plan, review it regularly and make any necessary changes if your life circumstances change.
Has anything changed your risk tolerance, did you start a family, or do you need to change your insurance coverage? All this will impact your overall financial goals so you will have to modify your original plan to get there. Review your financial goal at least once every six months.
Reevaluating your financial plan regularly allows you to deal effectively with unplanned occurrences, get back on your feet after major setbacks, and achieve your financial goals.
It’s one of the best things I’ve published (and 100% free), just tell me where to send it:
How much do you actually need to retire
If FIRE is not right for you and if you’re looking to live your Rich Life today, I have good news, and a number you can aim for.
$1.8 million. That’s how much you (and your partner) need to comfortably retire.
Let me explain.
- Retirement age: Let’s say you retire at 65.
- How long you’ll live: As of writing this, American women will live, on average, 14 years beyond 65, and men will live 8 years beyond 65—to ages 79 and 73, respectively. (Now you see why I want you to live your Rich Life now.)
- Income: Assume you make the median household income of $70,784 and want to continue your lifestyle in retirement.
- You need: $1.8 million ($1,770,100, to be exact).
That number isn’t random. It’s based on financial advisor Bill Bengen’s “4 percent rule,” which says that you can safely withdraw 4 percent of your portfolio every year of retirement—including increasing your withdrawals based on inflation—and not run out of money within 30 years. (To simplify the actuarial science, we use 30 years because you want to protect yourself from running out of money before you die.) Some bozos claim you can safely withdraw 8 percent per year (and “easily” make 12 percent in the market), but 4 percent is much more realistic. I cover this in more depth in I Will Teach You to Be Rich.
If you have $1.8 million in your portfolio, you can safely withdraw $72,000 per year—which, in this example, is exactly the current income you’re living on.
