Have you ever dreamed of leaving the rat race and just retiring early? Do concerns about financial security keep you from pursuing these goals? Financial stress is one of the most powerful psychological triggers in our lives. But the way out of money stress is to create a money plan – to imagine your ideal lifestyle, scrutinise your expenses, set your ‘retirement number’ and build wealth to achieve that goal. This is where the concept of FIRE originates.

The acronym F.I.R.E – Financial Independence, Retire Early first became prominent in the 1990s. The FIRE movement takes direct aim at the conventional retirement age of 65 and the industry has grown up to encourage people to plan for it. During their working years, FIRE investors invest as much of their income as possible in hopes of attaining financial independence at a younger age than traditionally thought of and maintaining it for the long term.

Sounds pretty good hey! Who doesn’t want to retire early?

How Does FIRE Work?

In the FIRE MOVEMENT, your target retirement number is known as your FIRE number. Essentially the idea is to create an investment that provides you with enough income each year to cover all your expenses. In order to calculate your Fire number, you need to understand what your expenses are and what sort of lifestyle you want in retirement.

Next comes the notion of the 4% rule. A common question people ask is, how much do I need in retirement (your FIRE number) or better yet, how much of your nest egg can you spend each year without running out of money in retirement?

In 1994, financial adviser William Bengen, from the United States answered this question in an article published in the Journal of Financial Planning where he found that retirees could spend about 4% of their retirement savings each year and that in most cases their retirement funds would last at least 30 years. I will say though there are a few assumptions here and there is a case to say that 5% could be taken each year if there were more exposure to shares, rather than 60% exposure initially examined by Bengen – This is a whole other topic.

How to Calculate Your FIRE Number 

It’s pretty easy to calculate your Fire number and you will notice that it all centres around your intended budget in retirement, which is why you need to think about what life looks like in retirement.

For example, do you want a comfortable retirement, which may mean you need to save more, or can you cut back on expenses and live more frugally, thus you would need to save less for retirement.

 

Your FIRE number is essentially whatever your planned annual expenses are each year multiplied by 25, or another way to calculate is annual expenses divided by 4%.

As I said before some people may operate on 5% (times annual expenses by 20 or divided by 5%). Some will even be more conservative and use 3%.

An Example FIRE Number in Action

Let’s look at a hypothetical situation. Eva’s Example calculates that her living expenses are $5,000 per month, which means her annual expenses are $60,000 ($5,000 a month times twelve months).

If Eva uses the 4% rule, her FIRE number would be $1.5 million ($60,000 times 25). To maintain her lifestyle without working at all, she’ll need $1.5 million in invested assets which provides an income of $60,000 per year.

Thinking about the relationship between your Fire number and your Budget

People who use FIRE to retire early do so by drastically reducing their expenses, looking for ways to increase their income, and then investing their surplus money into an investment portfolio, as a way to work towards their Fire number.

The majority of the FIRE movement is applying these basic principles to your budget:

  • Expenses. Budgeting is a key part of the FIRE lifestyle. Tracking expenses can help FIRE followers manage their money.
  • Spending. Some FIRE followers cut costs by eating meals at home, cancelling gym memberships and subscriptions, or driving older cars in order to increase their savings rate.
  • Income. Making more money could help speed up the financial independence process. To do so, FIRE followers might ask for raises, try to find higher-paying jobs, take on side hustles or create passive income streams.
  • Saving and investing. Members of the FIRE community may save 50% or more of their income to reach their financial goals. But FIRE doesn’t offer all the answers. Qualified financial advisers might help determine a savings strategy.

So, if we take the above example of Eva, who requires $60,000 per year to cover her expenses then she needs $1.5 million to achieve that. However, Eve decides to scrutinise her budget and determines she only needs $50,000 per year to cover her expenses, which means she only needs $1.25 million now. As she needs $250,000 less, she thinks she can attain early retirement….well, Earlier!

FIRE Limitations

Despite the benefits of the FIRE movement, it also has some limitations:

  • The FIRE lifestyle isn’t for everyone. Depending on one’s starting age, a FIRE plan can require strict sacrifices. Saving 50% to 75% of income might mean forgoing holidays, luxuries or nights out with friends but nothing good in life comes without sacrifice. What is better, working a job you hate until 65 or making the sacrifice now to build your investment to enjoy early retirement?
  • Facing the unexpected can affect FIRE finances. Life doesn’t always go as planned. Things such as injury or illness could impact finances in unexpected ways during retirement. This is why Personal Insurance (income protection, Disability, Trauma etc.) are imperative.

Bottom Line

The FIRE movement may not be for everyone but its key components—a disciplined approach to saving, investing, and budgeting—can certainly benefit you, even if you plan to stay in the workforce until the traditional retirement age.

That’s something to get FIREd up about.