What is Financial Independence, Retire Early?

Financial independence retire early (or FIRE) is different than the traditional retirement path.

It may sound complicated at first, but using insights like those on the financial index card can lead to retirement in just 10-15 years.

The typical path to retirement is the following: work for 40-45 years, saving about 10 to 15 percent a year, putting that money in some form of retirement account (employer 401-k, Roth IRA, thrift, etc.) and using that money to live out your golden years. There is nothing wrong with the traditional retirement path, but personally, it gives me a lot of anxiety.

I like working, so that’s not the problem. What worried me is the traditional retirement method does not save a lot of money each year. Plus generally, the younger you are, the better your health. I didn’t want to put-off living a life outside of work for when I am potentially too ill to fully enjoy retirement.

I began researching alternative investing strategies, and what I found is a strategy/community called the FIRE community. Financial Independence Retire Early.

What is Financial Independence Retire Early?

The idea of FIRE is to live below your means to save as much of your income as possible, preferably around 50%. Then you use this saved money to make more money, mainly through real estate rental and investing in the stock market. These investments generate passive income. The more money you have in these two places, the more passive income you generate. Letting your money grow over time with no work on your part.

Doing this process for ten-twenty years builds a habit of living frugally while generating a passive income stream that allows for early retirement. The idea is to get 4% of your desired take-home salary through your investments. You can then withdraw your investment returns each year without damaging the principal and future gains of your investment.

For example, if you want to live off of $100,000 for the rest of your life, you need to have $2,500,000 in a mix of investment assets that you can draw from. Saving $25,000 a year doesn’t seem like it will get to that  $2,500,000. However, $25,000 invested after 10 years earning the average return of 7%, will be $50,341. Doing this over and over again makes that number more achievable within 5-20 years. Over the traditional path of 40-45 years till retirement. By using the FIRE strategy, you can cut retirement in half, if not more if you are aggressive with your savings.

The book that introduced me to this FIRE concept was Set of Life: Dominate Life, Money, and the American Dream by Scott Trench. The basic premise is, “you need to earn more, spend less, and invest the difference aggressively throughout your journey, as they apply to the specifics of your situation.” It isn’t an easy process, but it can lead to a richer life. (pun intended).

The Benefits of Saving Money

In most developed countries, we are told by marketers we need a lot of things to do happy. That isn’t necessarily true and spending money on things costs a lot to our personal lives.

Money is a tool that can buy income-generating assets and time if used properly. Two of the biggest benefits of saving money are stability and peace of mind. Saving money provides stability because there is no longer the need to live paycheck to paycheck. If a surprise expense pops up, it can be paid by an emergency fund. If there are lay-offs or a pandemic, saving money can buy a few months of having the same life despite no income coming in. Having money saved reduces stress and makes it easier to hunt in the job market without having to worry about paying rent. The peace of mind that comes from this saved money makes it easier to job hunt and get your life back on track.  All of this leads to a foundation of stability and peace of mind.

Introduction to FIRE, How to Reduce Your Living Expenses by Half

According to Trench, sixty-three percent of the average American expenses fall into housing (33%), transpiration (17%), and food (13%). You can save the most amount of money by reducing your expenses in these categories. To show the difference between FIRE and traditional retirement, we will compare “average joe” vs. the FIRE method.  

1. Housing

“Find an apartment that can be affordably rented, make sure it’s as close to work as practical, and try to split the cost with a roommate or two.”

Trench

Nothing else will impact your financial health as much as the decision as to where to live. It is the single greatest purchase for many people, whether it is a rental or it’s your forever home.

Average Joe: Has a $50,000 a year salary and wants to live that way. He decides to live in one of the best parts of town to be where the action is and decides he doesn’t want a roommate because this isn’t college anymore. The apartment isn’t close to his new job, but that is okay, he can commute in, being downtown is more important. The rent comes to $1,500 a month.

FIRE Joe: Also earns $50,000 a year and decides to live closer to work. Which is a few extra miles from the best parts of town, but that is okay. He can commute to those areas on the weekends. He decides to split the apartment with a roommate to cut the cost in half. Between living further from the best areas and having a roommate, the rent is $550.

Comparison: At the end of the year, Average Joe spends $18,000 on his apartment, FIRE Joe spends $6,600. That is a $11,400 difference in one year just because of apartment selection. Even if FIRE Joe went downtown every weekend, he wouldn’t come close to this cost.

The path forward: How is your rental bill? Can it be reduced by moving closer to work, or living with a roommate? Just after two years, the money saved could be used for a down-payment on a home, or to put into the stock market to grow at around 7% a year.

2. Commute

Living close to work has a lot of benefits. Living close to work enables you to have more free time outside of work because less time is spent commuting. It lets you be more physically fit because you can walk or bike to work. There is less of a need to rush to get to work each morning because it’s just two miles away, which also reduces anxiety. Finally, it reduces wear and tears on the car – if you even need one.

Average Joe: Financially speaking to averages, Trent lays out the math below in his book based on the American average.

Average Joe commutes twenty-six minutes and sixteen miles to work, each way (x2).

The Government suggests it costs $0.54 a mile to operate a vehicle.

Average Joe earns $50,000 a year, or $25 an hour.

Driving to work costs $17.28 in driving costs and $21.67 in lost time per day.

That totals $10,125 a year. ($4492 with driving, and $5633 in work)

FIRE Joe: He doesn’t own a car and walks to work every day. He is healthier, less stressed, and has more time for his hobbies. He also has $4,500 extra cash in his pocket that he can use for income-generating investments. Also, if he maximizes his mornings working on a side hustle, he could generate more income beyond that of the $5,600 Average Joe has in lost labor charging. Which could accelerate FIRE Joe’s path to Time Wealth even quicker.

3. Food

Average Joe: Spends the American National Average of $3,000 a year eating out. Most of the food is also unhealthy, also costing on health.

FIRE Joe: Recognizes that restaurants mark-up the price considerably (as much as 300%) for the ingredients and the cost of paying for someone’s time to cook the meal. On average, eating at home costs half as much as it does to eat out for the same meal. That is not including the leftovers that the home-cooked meal generates. Assuming a conservative 50%, with some occasional meals out, FIRE Joe saves an extra $1,250 or so a year.

Learning to cook can allow us to make meals that will be eventually better than the food we could eat out and allows us to save half the cost (plus having delicious leftovers for lunch tomorrow). Having a growth mindset for cooking could lead to exponential gains for investment and your waistline.

How Much Did FIRE Joe Save?

At the end of the year, will all the reduced expenses, FIRE Joe saved $12,350 more than Average Joe. This is also just touching the three biggest typical expense areas. By living more frugally and saving money, Average Joe can use the money to invest in income generating assets.

Average Joe is on his path to retire in 10-20 years, while average Joe is continuing to live his expensive lifestyle.

This is the benefit of learning what is financial independence retire early.

Benefits of FIRE

1. Increased Flexibility: Not having to live paycheck to paycheck lets you look for other work opportunities, and if you lose your job, you can sustain your standard of living for a little while.
2. Less Stress: In pursuing FIRE, you can realize you don’t have to “keep up with the Joneses”. You will realize you don’t need a lot of things, and not living paycheck to paycheck lets you have more peace of mind.

It isn’t easy, and it is all done through active choices. I like the high savings rate idea, and using the FIRE model avoids lifestyle creep that can eat-away hundreds of thousands of dollars over our lifetime. 

Main Take-Aways:

• Reducing the cost of housing, transportation, and food can save tens of thousands of dollars a year ($22,775 in this example). Use those funds to build an emergency fund, and then invest the remaining amount into income-generating assets that grow over time. Doing this year over year can lead to financial independence to retire early.
• Aside from the monetary and early retirement gain, saving money provides a financial runway that can be used to pursue exciting opportunities and also reduces anxiety.

Action Items

How can you reduce your spending in each of these three categories to work towards saving more money every year? Set time each day this week to look over your expenses and see how you can save more money.