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.
