If you have stumbled upon my little blog you may be wondering what the hell I am going on about.
PURSUIT of FIRE isn’t a site dedicated to pyromaniacs. FIRE stands for Financial Independence, Retire Early and is the movement for people dedicated to becoming financially independent and retiring much early than most financial advisers think is possible.
The traditional notion of retirement which most people are familiar with, is to save 10% of your income into your pension, work for 30 to 40 years and then retire when you are between 60 and 70 years old. Hopefully by this time you will have several million saved and you can safely retire.
You then spend your retirement on the beach, playing golf, traveling and doing all those activities that you never had the time to do while you were working.
However, I have a few issues with this:
Financial planners paint the rosy picture of retirement, a grey haired couple smiling, holding hands on a park bench, watching their grandchildren play in the park.
The reality is many pensioners are constantly worrying about having enough money, are either widowed or at least one of them have significant health issues. Those that do finally go on that once in a lifetime cruise trip can’t even do the exploring they wanted to do due to arthritis and other health issues.
Take a very simple example. You start by earning £25,000 a year for 30 years with your income increasing every year with inflation (2.5% in this example). You save 10% into your retirement account which is invested in stocks and grows at a rate of 10% a year.
After 30 years you would have £511,728 saved, your salary in your last year of retirement would have been £51,160.
Generally this would be enough to retire on. However, lets assume you have let lifestyle inflation creep in. To make ends meet you need the same salary as you had before you retired. This amounts to withdrawing 90% of your final salary (£46,044) each year at a rate of £3,837 a month increasing each year with inflation.
In this scenario your pension pot would last just short of 25 years. If you start saving for your pension at 25, you retire at 55, then you will run out of money by the time you are 80. However, if you only withdraw 75% of your final salary (£38,370) then your pension pot will last forever. By the time you are 80 it would be worth £1,136,687.
Not bad but you still need to work for 30 years to get to that point.
The alternative is to gain your Financial Independence or should I say your Life Independence and do those things you enjoy doing while you are young enough to still do them.
There is an age old saying, “Youth is wasted on the young”. People never appreciate what they have now and are always looking into the future when everything will be “better”. However, when they get to the future they wish they had taken time to enjoy themselves while they could.
The aim of financial independence is to build up your nest egg while you are young by saving more than the 10% recommended by experts. On top of that, if you can find a way to earn some “passive income” then you will get to financial independence that much quicker.
The premise is simple. If it takes you 30 years to retire by saving 10% of your salary, then surely you can retire quicker by saving even more of your salary.
Let’s assume you are trying to save 25 years worth of expenses. The amount you save really can affect how long it takes for you to retire.
If we take a simple example where we earn no interest and there is no inflation. At 10% it would take 9 years to save up 1 year worth of expenses. 25 years worth would therefore take 225 years!
Thankfully we do live in a world where we can earn interest on our savings, which is why even at 10% you can still retire after 30 years of saving. Compound interest only really comes into play over a period of 10 years or more. If you are looking to retire in 3 years then that 90% savings rate may still be needed.
However, for those who can live on 25% of their income it can take less than 10 years to save enough for retirement.
For most however, living on only 25% of your income will seem unfathomable. For some, it is in fact impossible without increasing your income. This is why the FIRE movement is most popular with high earners. For those couples working in San Francisco each earning $200,000, 25% still leaves them with $100,000 to live on.
Let’s take an example to see how this would look on a more realistic income.
In this example the take-home annual salary would be £35,532 (£2961 / month). Given we are looking to retire early, I am going to ignore the pension contributions for now. However, this would provide you with another income when you do hit retirement age.
So lets look at a few scenarios:
The 3rd example on that list I would consider a stretch goal. Depending on your circumstances you may not be able to live on £1776.60 per month but it isn’t ridiculous.
Now lets assume an average stock market yearly return of 10% and average inflation of 2.5% and your salary increasing with inflation each year.
I will be coving this in more detail later but I will cover it briefly now. The 4% rule dictates how much you can withdraw from your portfolio so that you never run out of money. The first year of your retirement you withdraw 4%. Every year after that you withdraw the same amount but adjusted for inflation.
This method assumes a 7% return on investments with 3% for inflation.
For example if you have £500,000 saved, then you can withdraw up to £20,000 (500,000 * 0.04) the first year. Then withdraw £20,000 each year adjusted for inflation. That way you should never run out of money.
If you want to work out how much you need to save for retirement the inverse is true. If you want to withdraw £35,000 a year then you need to have 25 times that amount saved, £875,000.
The downside of this calculation is that you also need to adjust for inflation. If you are decades off from retirement then you need to multiple your required salary by how much it will increase with inflation. Assuming a 2.5% inflation rate we get:
I am going to go into more detail about more of these topics in future as well as what we can do to get that savings rate up!
Alex started Pursuit of FIRE in 2019 to try and help people reach financial independence. He has spent nearly a decade working as a software developer in the finance industry and now is looking towards early retirement so he can spend more time with his young family.