The Fire movement is a growing trend amongst young workers which is growing
in popularity thanks to its very enticing goal which is spelled out in the name.
FIRE is an acronym of Financial Independence and Retiring Early.
The idea is that by following a very aggressive saving and investing strategy people can get to
a point where they are effectively retired at a very young age, sometimes younger than 30.
In a world where we are being told that pensions are running dry and the average person may
have to work in some capacity for their entire life, this sounds like a bit of a lofty dream.
Sure, there are trust fund babies and young tech millionaires who may earn
millions within their first few years in the real world, but surely kicking back on beach
and never thinking about work again is not attainable to a regular wage slave right?
Well if some figure heads and internet forums are to be believed then well,
yeah actually it is for pretty much anybody.
Now in the interest of full disclosure I am a passionate advocate for the financial
independence movement. But that does not mean that I don’t see issues with it.
Now many of those issues are glossed over in the sheer simplicity of it,
which is also part of the reason it is so powerful.
So long as someone can get to a point where their investments are making as
much as their living expenses long term, they have achieved financial independence.
Getting to that point is harder for some than others, but advocates of the movement
argue that this difficulty has more to do with personal lifestyles rather than personal incomes.
So what are the mechanics of the FIRE movement?
How could someone use it to stop working forever?
Is this actually attainable for anybody like they say?
And finally
What would this movement do to the wider economy?
If everybody strives towards a goal where they quit working at age thirty
shurely this would bring our world to a grinding halt right?
Well if we can properly explore and answer these questions
we will be able to reveal if this whole thing is grounded in reality
or if it’s just a fanciful pipe dream for people who really hate their boss.
INTRO ADD
Now if you are thinking to yourself that this idea of retiring at age thirty sound pretty compelling
the first thing you need to do is really understand how this system works.
So outside of broad statements like saving and investing, what are the
NUTS & BOLTS OF FIRE
There are historical figures for a range of very important factors in the economy
which help us in a sense make projections into the future.
The assumptions that are relevant to the idea of FIRE are that a well diversified investment
portfolio should return around 8% per year, and that inflation is around 2-3% per year.
Some of these figures can change
but with this we get the foundation of being able to live forever off your portfolio.
For example if you had a million dollars invested into a broad market index fund
you would normally expect that over time the returns from this portfolio to be around that 8%,
and for the past 100 years or so that has been correct, on average.
This return would be split up between dividends and capital appreciation,
in otherword the rise in the price of the stocks within the index.
What this means is that effectively you would be able to draw $80,000 from
this portfolio every year and it would maintain it’s value.
Now $80,000 is a pretty comfortable lifestyle for most people in most cities around the world,
and while saving a million dollars is obviously hugely difficult, it’s not impossible for people
in good professional careers, especially if we are looking at a dual income household.
But there are two factors that make this a little bit more difficult than it would initially seem.
The first is inflation, the Federal Reserve Bank of the United states targets a 2% inflation rate.
In 1960, the equivalent of an 80,000 salary today was around $5,600 per year. Since the
FIRE movement is all about retiring at a young age and enjoying a long life without
the need to work you should realistically be planning for at east the next 50 years.
At a 2% rate of inflation in 50 years time, that $80,000 a year that you are pulling from
your investment portfolio would only be the equivalent of a $32,000 salary today.
I mean you could still scrape by in a low cost area of the united states,
but it’s far from comfortable and it might put you in a position where you need to go
back to work at the age of 70, after 40 years out of the workforce…. Good luck...
What that means is for this million dollar portfolio to maintain its real value,
you would need to put back in $20,000 per year, to fend off that 2% inflation rate.
Not a huge deal, but that means now you are only left with $60,000 per year to live on.
Beyond that some people want a bit of a buffer in their investment growth so
it is normally suggested to reinvest at least 3% back into your portfolio year on year.
Alright so now all of a sudden we are living on $50,000 per year for
the rest of our lives and this is before we get to problem 2.
There is a strategy in investing called dollar cost averaging
and it is a really powerful thing to understand.
The idea is that the market is erratic and mostly unpredictable, but over time it trends upward.
So if you consistently invest at a set time interval, like lets say once per month
you are going to get the most out of the market for 3 reasons.
Reason 1 is that it takes the emotion out of investing,
if you automatically set money aside and don’t think about it you aren’t going to
be tempted to buy into the next hot stock or pull your money out at the bottom of the market.
Reason 2 is that it gets your money to work right away, if you hold off on investing for
a year or until you have done research on a particular stock or whatever you will be
missing time in the market to generate returns. Since on average the market returns 8% per year,
if you hold off investing $10,000, you would already be $800 behind
someone dollar cost averaging. Time in the market beats timing the market as it were.
Now the third reason is the most powerful and also the hardest to understand.
The key to investing is buying low and selling hight right?
Well by investing at set intervals you are kind of doing this by default.
If for example you invest $1,000 a month into walmart stock it would depend on the
price of the shares as to how much stock you buy. For example if it is trading at $100
per share you would be able to buy 10 shares, simple enough.
But lets say the price doubles to $200 per share, well at that price
your $1,000 monthly investment is only going to buy 5 shares, and the same is true if the
price drops to $50 per share where suddenly you are going to buy 20 shares per month.
By maintaining a consistent investment pattern this hypothetical investor
has bought more shares when they are cheaper, and less shares when they are more expensive,
giving them a win in atleast one side of the buy low sell high debate.
The problem with all of these benefits of dollar cost averaging on the buy
side is that they are drawbacks on the sell side.
If someone is drawing $5,000 per month from their portfolio to maintain their living expenses
then they are naturally going to sell of more of their shares
when they are cheaper then when they are more expensive.
For all of these reasons most people in the fire community work around the 3% rule.
This rule is created by starting with an 8% expected return
and then deducting 2% for inflation, 1% for market volatility, 1% for the
impacts of negative dollar cost averaging and 1% as a comfortable margin of safety.
In plain english what this means is that if you can live off 3% of your investable
net worth every year before considering taxes, congratulations you are financially
independent and you will continue to be into eternity, all other things being equal.
But 3% is not huge, if you wanted to live off $100,000 per year,
you would need $3.3 million dollars invested.
There are some people that will push this 3% rule to a 4% rule to be a little riskier
but retire a little sooner but the fact of the matter it you still need to be pretty damn rich.
The idea that anyone can do this is simply not true, but it might still
be less daunting than these numbers would suggest, and infact there are even Tiers
of the fire movement to account for this so how could an average person,
Stop Working Forever?
While making enough money to live forever on $100,000 a year might sound almost impossible,
many pundents of the movement argue that this is far from necessary. And that infact FIRE
is more so about really assessing what you value rather than earning lots of money.
If you value material things and want to be able to go on multiple holidays per year to
exotic destinations thats fine but you are going to have to give up a little bit more
of your time and spend slightly longer in a career building up an investment portfolio.
Other people might be perfectly content to live in low cost of living areas and pursue
low cost hobbies which means they will need far less money to be financially independent.
What this means is that how quickly you can retire
is determined by your savings rate, rather than your gross savings.
A nurse earning 60,000 per year after taxes and living on $30,000 per year,
should be able to retire within 16 years at a 3% safe withdrawal rate.
A neurosurgeon on the other hand might be earning $500,000 per year after taxes
but after an expensive mortgage, private school fee’s,
exotic holidays, and student loans they might end up spending $400,000 per year.
What this means is that it would take this doctor 28 years to get to a point
where they could maintain their lifestyle indefinitely off their investments.
Now both of these instances are the result of personal choice, if the neurosurgeon loves his job
and loves his nice things then all power to them, but if they dislike their job the fire movement
advocates for properly assessing if you like that new porsche as much as dislike 6 months at work.
Now of course for some people this maths simply doesnt work, you can only lower your
living expenses so far before you push yourself into poverty and unfortunately
the reality is today that alot of people out there can’t afford even a basic lifestyle
while still having money left over to save.
But for those who can its extremely important to think about major financial decisions in terms of
opportunity costs, with the missed opportunity being years that you could spend, sleeping in,
working on hobbies, or traveling rather than sitting in an office.
Now this is all well and good on a macro economic level
if this was to really take off surely it is not sustainable.
How would a world without workers Work?
We have explored the labor market twice in the last 2 months and
both times we have found that human labor is very important
to maintaining a functioning economy, not to mention a functioning society.
This shouldn’t be a huge surprise to anybody
least of all people who sit down to watch video’s on economics.
But what might surprise you is that there might be an alternative.
Consider this thought experiment.
Someone is working and saving half of their income.
With that money they buy a farm, they then pay to have a workshop put on that farm,
and then they pay to have machines automate the planting and harvesting of crops.
They also pay to have a mine with access to basic materials set up, and robots to harvest
and refine those metals aswell. Finally their workshop is kitted out in all of the latest
technology to allow them to produce anything their little heart desires, from scratch.
Well in this example this person would be completely
financially independent (assuming they don’t have to pay land taxes)
Now this hypothetical is sure to make alot of ranchers and off the grid folks very excited
but its not too different from what FIRE practitioners are doing.
All of the things our hypothetical worker bought were either land or capital goods,
as in machinery or technology that makes making stuff possible.
Now in this very direct example, this individual was investing in things that would be used to
produce goods and services for themselves. But more realistically a real person would use their
money to invest in things that would be used to produce goods and services for everybody.
They would then charge everybody the rights to use their productive
capacity in the form of profit which would be paid out to them as dividends
and would in the real world likely have a company acting to facilitate this.
In a sense Financial Independance is like crowdsourced independence,
using financial instruments to make the process of living off machinery and land more efficient.
So would a mass uptake in FIRE practitioners ruin the economy? Well short term
yes, the drop in consumer spending and rush to financial markets would cause
alot of volatility, but long term it is theoretically possible.
We explored this idea of an automated future where capital goods completely
replaced labor in the factors of production in our video on Automation.
I don’t want to repeat too much of that hear,
but a big takeaway was that this capital intensive future could be a utopia,
or a complete disaster depending on how this inevitable transition was handled.
Final Thoughts
The financial independence retire early movement is certainly not
something that is going to be the right fit for everybody.
For many the cuts to their lifestyle are just not worth the extra few years out of their careers.
There is also of course the psychological aspect of not having anything to work towards.
Go play a sandbox game with unlimited money hacks to get an idea of how quickly it can actually get
pretty boring without some kind of a challenge.
There are theories and suggestions that go a long way to remedying some of these more
psychological issues, but again that is not our area of expertise here at Economics Explained.
Instead from a pragmatic economist point of view the FIRE movement’s biggest takeaway
might be the lesson it gives us in the trade off of time for stuff.
If you start thinking about purchases in the form of how many hours you need to work to buy
something you might be less tempted to splurge.
70 hours of team meetings for that new iphone, 30 hours working through excel
macros to pay for that new outfit, 10 lame excuses as tyo why you were late to buy
dinner at a fancy restaurant. For some people it’s worth it, but for many people it isn’t.
For the people that don’t think it’s worth it, sometimes the daunting prospect
of actually starting to invest is the only thing holding them back.
Fortunately this first step can be made a lot easier.
With acorns.