Being financially free allows you to escape the immense stress of living paycheck to paycheck, and the sooner you begin working toward this goal, the more realistic your early retirement dream will be.
Setting clear objectives and diligently pursuing each one is the first step toward overcoming financial stress.
This article outlines a comprehensive and simple 7-step process on how to achieve financial independence and retire early.
What is FIRE (Financial Independence, Retire Early)?
Financial Independence, Retire Early (FIRE) is a movement of people committed to extreme savings and investing to retire far earlier than traditional budgets and retirement plans would allow.
Also Read: The Essential Phases of Retirement Planning: A Comprehensive Guide
In 1992, Joe Dominguez and Vicki Robin published “Your Money or Your Life,” which contributed to the FIRE movement’s initial success. To become financially independent and lead a life that is consistent with one’s values and aspirations, the book explores how to modify one’s relationship with money.
Early retirement and financial independence are achieved by FIRE philosophy members through aggressive saving and investing.
“You can retire early, in your 40s, if you start planning early.” According to Vishal Dhawan, founder, and CEO of Plan Ahead Wealth Advisors, “to achieve this, a clear strategy must be built on how this will take place, i.e., separation of essential expenses and nice to have expenses, a good estimate of the retirement corpus needed, and a strong savings and investment rate.
What is the Purpose of FIRE?
The FIRE movement emphasizes aggressive investing combined with extreme frugal living to achieve greater financial independence. FIRE followers may aspire to achieve greater economic independence or retire before the typical retirement age range of 65 to 70. Individuals aspiring to retire ahead of schedule may decide to survive only on modest withdrawals from their investments or include part-time employment in their plan.
Advocates of the extreme-saving lifestyle continue to work for many years while setting aside as much as 75% of their annual income. They may resign from their day jobs or retire when their savings reach their FIRE number, which is usually 25 times their annual expenses.
FIRE enthusiasts take small annual withdrawals from their savings, usually between 3% and 4% of the total, to pay for living expenses after retiring early. This calls for a great deal of attention to detail when it comes to keeping an eye on their spending and allocating their investments, depending on the amount of savings they have and the kind of lifestyle they hope to maintain.
How Does FIRE Work
By drastically cutting costs, finding ways to increase income, and investing their savings in a combination of regular brokerage accounts and tax-advantaged accounts, people who use FIRE to retire early do so.
Living the FIRE lifestyle, however, comes with a price that not everyone can afford; to have additional funds for investments frequently necessitates reducing spending to the absolute minimum.
FIRE followers may save 50% to 70% of their income or more, which is not feasible for everyone, according to Burns.
She claims that some people are unable to live simply, possibly as a result of having a family.
However, if you’re interested in the underlying theories of the approach, FIRE practitioners frequently take the following factors into account when deciding on a course of action:
Rule of 25
The “Rule of 25” helps you figure out how much money you need to save if you want to retire. Here’s how it works: first, add up your monthly expenses and multiply that by 12 to get your yearly expenses. Then, multiply your annual expenses by 25. This gives you the total amount you’ll need to save for retirement, also known as your FIRE number.
For instance, if your monthly expenses are $4,000, multiplying that by 12 gives you $48,000 for the year. Then, multiply $48,000 by 25 to get a FIRE number of $1.2 million.
If saving 25 times your annual expenses feels overwhelming, you can always prioritize increasing your income and investing the extra money to reach your goal faster.
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The 4% Rule
According to the 4% rule, retirees can take out 4% of their savings in the first year and, if required adjust in subsequent years to account for inflation to ensure they have enough money for retirement. Additionally, the 4% rule is based on a 30-year retirement goal, so it might not apply to you if you want to retire early.
According to Burns, investors need to exercise caution when following advice intended for a broad audience, particularly concerning the calculation of a FIRE number.
“I often hear people say things like, ‘You need this much money to retire,’ or ‘You can safely take out 4.5% each year.’ These are just broad general rules, but like most financial advice, it’s not the same for everyone,” says Burns.
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The Ideal Savings Rate
If you plan to retire early, consider how much you’ll need to invest and save each year to get there.
Paris Woods, New Orleans-based author of “The Black Girl’s Guide to Financial Freedom” and supporter of FIRE, suggests selecting a savings rate that corresponds with the pace at which one desires to achieve financial freedom.
To become financially independent in ten years or less, Woods advises setting aside roughly 70% of your income.
Magic of Compound Growth
Physical money kept in a bank account would probably not be enough for you for the next 40 years due to inflation. However, because of compound interest, investing in and saving money in tax-advantaged retirement accounts can be beneficial.
You can use 401(k) and IRA accounts to invest for your retirement. Although you must pay taxes upfront, your investments grow tax-free, and you can take qualified withdrawals from your Roth IRA without paying any taxes when you retire. In contrast, cash withdrawals from traditional IRAs and 401(k)s during retirement are taxed, but the tax-free growth and compounding returns remain available to you.
However, there are annual contribution caps for both 401(k)s and IRAs. What occurs then if all of your retirement accounts are fully tapped out? Where will you next invest and save money?
According to Burns, “Invest as much money as you want in a regular brokerage investing account.” “You can add as much as you want to that.”
Your risk tolerance will determine what you invest in bonds, stocks, or funds like exchange-traded funds (ETFs).
FIRE also requires you to stay invested even during times of market turmoil, Burns says.
FIRE is a long-term strategy; you can’t respond rapidly enough to sudden changes in the economy. Based on market developments, you might need to modify your spending or saving in some years, but your overall plan should remain the same.
Tax Saving Strategies
When planning a strategy, one thing you should consider is how much money you’ll need between your target retirement age and the age (typically around 59½) at which you can begin taking penalty-free withdrawals from your retirement accounts.
After you’ve determined a figure, you might want to save that sum in your standard brokerage account. That way, if you do decide to retire early, you won’t run out of capital before you can begin taking qualified distributions from your retirement accounts.
When you withdraw money from a regular brokerage account, you will still have to pay taxes, but there will be no early withdrawal penalties. According to Burns, you will also have to pay taxes on dividends and interest from your investments, as well as when you sell them for a profit.
How to Achieve FIRE Lifestyle
1. Clearly Define Your Financial Goals
Set clear goals for your finances at the beginning of this process. Write down the measurable components of your goal and visualize what financial success would look like for you.
You’ll be able to create a targeted plan more easily if you can define your goals more precisely. Provide accurate amounts, deadlines, and tangible benchmarks.
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2. Track and Analyze Your Spending
You’ll find it easier to find areas where you can cut costs if you have a clear understanding of exactly where your money is going. Consequently, tracking and analyzing your spending so you can retire earlier is the next step to improving your current financial situation and spending habits.
You can use pen and paper, spreadsheets, or money-tracking apps—whichever is most convenient for you—to keep track of your finances.
It will be simpler to proceed to the next step if you are more thorough in keeping track of all the cash you spend.
3. Create a Budget
After you’ve determined how much you spend each week or month on particular categories, make a budget that cuts out unnecessary expenses. The goal of budgeting is to save money after covering your living expenses. Thus, make sure to set aside funds for a savings category.
When making a budget, it’s a good idea to abide by the 50/30/20 rule. According to this rule, you should set aside 50% of your after-tax income for savings and debt repayment, 30% for wants, and 20% for needs.
4. Build an Emergency Fund
Save enough money for three to six months’ worth of expenses before moving further. That’s the amount that a lot of experts suggest saving in an emergency fund. Your savings should be sufficient to cover you during employment, unexpected expenses, or other unforeseen circumstances.
5. Pay Off Your Debt
One of the biggest obstacles to financial independence is debt. Therefore, it’s advisable to pay off your debt as soon as you can to avoid having to make high-interest payments over time.
Think about utilizing the debt avalanche or snowball approaches when creating a repayment plan for your debts. The debt avalanche method gives priority to paying off debt with the highest interest rate, whereas the debt snowball method focuses on paying off your smallest loan balances first.
You can accelerate your path to financial freedom and stay on track with your debt repayment journey by using these achievable strategies.
6. Create Multiple Streams of Income to Achieve Financial Freedom
Achieving financial independence requires diversifying your sources of income.
Even if one of your income sources is compromised, having multiple sources of income allows you to save more and reduces your risk of debt.
To supplement your main source of income, you can look for a part-time job, start a side gig, or launch a small home-based business.
7. Save for the Future
You only need to save for the future until you achieve your desired net worth after making multiple income streams, paying off your debt, and optimizing your budget.
Of course, you can always improve along the way—for example, by adding more income streams or raising your monthly savings. But if you follow through on your plan, your chances of retiring as early as possible and financial freedom are favorable.
The Bottom Line
The Financial Independence, Retire Early (FIRE) movement represents an alternative to traditional retirement planning. Several FIRE participants aim for an earlier retirement age rather than 65. While some intend to continue working, their goal is to become financially independent, which means they will not be dependent on a steady salary from a full-time job.
You must make thoughtful strategies if you want to pursue FIRE. Remember that the standard retirement guidelines are meant for individuals who will only be out of the workforce for about 30 years. If your objectives and tactics need to be adjusted, think about consulting a financial planner.
