Achieving Financial Independence, Retire Early (FIRE): Complete Guide
Simply put, financial independence is when you start making more from your investments than you spend annually. You no longer have to work to earn a living or worry about making rent payments on time.
You are free from having to work for a living.
BUT how long would it take the average American to become financially independent?
Assuming you earn $75,000 a year and your annual expenses are about $60,000, you need to save roughly $1,500,000 to become financially independent.
How do you do that exactly? That’s what we’re here for.
What does it mean to be financially independent?
Ramit Sethi, founder of I Will Teach You to Be Rich and best-selling author, defines financial independence as the state of having enough income from your investments to cover all your living expenses for the rest of your life without having to depend on employment or other people. Revenue generated from those investments without working is passive income.
What is FIRE?
FIRE, or ‘Financial Independence, Retire Early,’ is a commitment to a program of investing and extreme savings that allows proponents to retire earlier than retirement plans and traditional budgets would facilitate.
Proponents of FIRE dedicate up to 70% or more of their income to savings by sticking to frugal saving tactics which allows them to quit their jobs and live the rest of their lives on small withdrawals from their portfolios decades earlier than the conventional age of retirement.
There are four different variations of the FIRE movement that dictate the lifestyle people can and are willing to live by:
- Fat FIRE: An individual with a more conventional lifestyle who saves more money than the average retirement investor so that they may continue to live a comfortable lifestyle after achieving FIRE.
- Lean FIRE: A person that strictly adheres to extreme servings and minimalist living, a more restricted lifestyle both before and after reaching FIRE.
- Barista FIRE: People who quit their conventional nine-to-five jobs but still have some kind of part-time employment to take care of current expenses, which would otherwise deplete their retirement fund. In simple terms, they need part-time jobs to make some extra income.
- Coast FIRE: People with part-time jobs who have saved enough to take care of their everyday living and retirement expenses. These people do not need to work even on a part-time basis as their savings can cover all their expenses.
How to achieve financial independence
There are no shortcuts or get-rich-quick schemes if you want to achieve financial independence. If you are an average person that needs $1.5M to achieve your FIRE goal, you need to put in a lot of hard work and determination. However, the satisfaction that comes with the freedom you get through financial independence makes it all worth the struggle.
Set a goal with the 4% rule
In all our examples, we’re going to use the $1.5M goal based on the salary and living expenses of the average American. If you want to find a number more accurate to your individual situation, you will have to use the 4% rule.
Also known as the safe withdrawal rate, the 4% rule refers to the amount you should comfortably withdraw from your savings to cover your expenses every year after retirement without touching the principal.
Determining your safe withdrawal rate is the first step towards learning how to achieve financial independence. So, how do you determine how much money you should save?
- Determine your annual expenditure. It should cover any expenses you can spend in a year, including utilities, gas, groceries, rent, etc.
- Multiply it by 25 (years). The number may vary depending on how many years you plan on retiring.
- This should give you enough expenses to withdraw 4% for more than just a few years. For every $10,000 you spend a year, You should save $250,000 to achieve the financial independence goal.
Here’s a handy chart to show you how much you’ll need to save based on possible yearly expenses.
|ANNUAL EXPENSES||Financial Independence Goal|
Using the above information coupled with your annual after-tax income, you’ll be able to come up with an annual savings rate (i.e., how much you need to save each year).
It would help if you always remember to factor in your yearly income, after-tax. You can also tweak the numbers until you reach a savings rate that you can comfortably handle. This should give you an idea of how much you should save every time you receive your paycheck.
In terms of percentage of income, your savings rate will vary based on your earnings and FIRE goals. Many FIRE members suggest that you should save an average of 50% of your total income to help you achieve your financial independence goals.
When subscribing to FIRE, you lock yourself into a similar lifestyle once you achieve your financial independence. Therefore, start embracing the lifestyle you want and use it as a basis for your financial independence target if you are making many economical choices.
This takes us back to our example: The average American needs to save about $1.5M if they want to retire early. In this case, the average savings rate will be 32% of the yearly income every year.
Anyone that chooses to pursue financial independence needs to ask themselves whether they should try to live as frugally as possible in exchange for early retirement and keep their expenses low or whether they want a more refined lifestyle but to retire later. The good news is two communities embrace FIRE in various ways and can help you decide.
…but you don’t have to take the same path as everyone else. How would it look if you designed a Rich Life on your own terms? Take our quiz and find out:
Choose Your FIRE Lifestyle
Financial independence revolves around two schools of thought: leanFIRE and fatFIRE. Although they are both meant to help you achieve financial independence, the option you choose will impact various aspects, such as how much you spend, the quality of life, and how much you save.
This method requires one to maintain a low expenditure annually (ideally, not more than $40,000 every year). You may have to get rid of some luxuries such as trips and vacations and maintain a frugal lifestyle. It can even limit the number of places in the world you can afford to live in.
For instance, you can spend less living in Norman, Oklahoma, than someone living in New York City. Barista FIRE also falls under this umbrella, where you may have to work a part time job to afford any extras that you want.
On the other hand, you can subscribe to a different FIRE movement that allows you to stick to your financial independence goals while maintaining a semi-luxurious lifestyle.
FatFIRE refers to a method of pursuing financial independence that allows you to enjoy a relatively luxurious life. However, it takes longer to achieve financial freedom.
With FatFIRE, proponents maintain a more standard spending level. Your expected expenditure should be slightly above the national average. The figure will vary, but might start at about $80,000. Using $80,000 as an example, you should save about $2M to maintain a budget with a yearly withdrawal rate of 4%. To many, this is the ideal lifestyle.
Strategies for achieving financial independence
If you are not willing to sacrifice your $80,000-a-year lifestyle, you still want to achieve your goal by saving enough. You will need to earn more and increase your rate of saving.
1. Earn more money
It will take you more than 26 years to save up to $1.5M if you earn a salary of $73,000 every year and save an average of 70% of your total income. That is too long and too aggressive for anyone that wants to retire early.
The good news is you can significantly shorten this time by earning more money. With more income, you can increase how much money you save and increase the rate at which you secure financial independence goals.
Although there are many different ways to earn more money, starting a side hustle is the most effective option.
2. Create a plan
It is almost impossible to achieve financial independence without a financial plan which allows you to save money and pay for what you love while staying on the path towards achieving your financial goals. Although everyone wants to gain financial independence and build wealth, we all have different financial plans.
You can create a reliable plan to help you achieve financial independence by knocking out your financial goals. Without goals, you will have a hard time reaching your financial success.
They enable you to understand what you want to achieve. Once you know your goals, create an emergency fund and clear any debts you have.
Also, make a plan to invest as it helps you build wealth which is a vital part of achieving financial independence. Your goal should also include a plan for retirement, taxes, estate, and insurance.
3. Have an emergency fund
Unanticipated financial expenses can significantly destroy your financial plans, especially when you don’t have the cash on hand to take care of them.
About 36% of the American population say they cannot comfortably take care of a $400 emergency in cash. You can run into anything such as loss of employment or a job layoff, or a long-term ailment that stops you from working.
Life could even throw a different financial challenge your way, and you will have a hard time making it through if you have to start from zero dollars in savings.
An emergency fund refers to money you put aside to take care of unexpected financial emergencies or expenses such as home repairs, unscheduled car repairs, unexpected medical bills, monthly expenses after a job loss, unexpected veterinary bills, and more.
You need to follow some rules when creating an emergency fund. Although financial experts recommend saving up to six months worth of living expenses in your emergency fund, you can start with a small amount and make your way up depending on your financial goals and needs.
Always consider the number of people in your household, how many of them have a source of income, the minimum amount you need to take care of monthly expenses, and the stability of your sources of revenue.
4. Invest in tax-advantaged accounts
You can minimize how much you pay in taxes and maximize the amount you retain through tax-advantaged accounts for your investments. With traditional investment or savings accounts, you pay taxes in the year you receive earnings.
On the other hand, tax-advantaged accounts allow you to decide when you pay taxes on contributions you make to the account and any profits you receive.
A tax-advantaged account is a form of financial account or savings plan that allows you to access different tax benefits. With a tax-advantaged account, you defer tax payments to a later date or qualify for exemption from paying taxes altogether.
There are two types of tax-advantaged accounts, including the pre-tax or tax-deferred investment accounts, which push your tax payments on any money you deposit into the account to a later date.
If you have an after-tax investment account, you deposit money on which you have already paid taxes. In this case, you do not have to pay taxes on any money you withdraw from the account.
The health savings account (HSA) is one of the best examples of a tax advantaged account. It offers an appealing option if you have health insurance plans with high deductibles. You can contribute pre-tax income to the account and later withdraw the money tax-free when used to pay qualified medical bills.
In simple terms, you’re able to set aside money to pay medical bills without having to pay any taxes on them. Other tax-advantaged accounts include Roth accounts, 529 plans, health flexible spending accounts (FSA), and more.
5. Diversify your investment portfolio
Diversifying your investment portfolio allows you to reduce risks by locating various investments across different industries, financial instruments, and other categories. With diversification, you do not put all your eggs in one basket.
It helps you maximize returns by channeling investments into different fields that react differently to a single event. If anything goes wrong with an investment in one field, you have the security of the others.
Diversification does not guarantee against loss, but it is essential to achieve your long-term financial goals with lower risks. To diversify your investments, you need to have different types.
Ramit advises people to invest in long-term, low-cost index funds that are diversified by nature and never require you to rebalance to maintain risk level
6. Cut costs
Most people sweat over the prospect of cutting costs. The thought of being unable to eat at your favorite restaurant or do something you enjoy often come up.
It doesn’t have to be the case. By cutting costs, you should focus on cutting costs mercilessly on things you don’t care about. Then if you still want to spend on a few things that really bring you joy, you can do so guilt-free. When you see a new car that you love, think about whether you want to get the car or if you want to work for a year less and still achieve your financial goals.
Cutting things that you don’t love or need gives you the idea that you are working towards achieving your financial freedom. It is what we call conscious spending.
It allows you to determine precisely how much you can afford to spend without having to worry about paying rent or covering other bills because it is already taken care of through automated payments.
However, if you want to achieve financial independence, you may wish to adjust the amount of money you save when implementing your plan.
7. Reevaluate your goal regularly
Once you have a financial goal and outline the financial plan, review it regularly and make any necessary changes if your life circumstances change.
Has anything changed your risk tolerance, did you start a family, or do you need to change your insurance coverage? All this will impact your overall financial goals so you will have to modify your original plan to get there. Review your financial goal at least once every six months.
Reevaluating your financial plan regularly allows you to deal effectively with unplanned occurrences, get back on your feet after major setbacks, and achieve your financial goals.
FAQs About How To Achieve Financial Independence & Retire
What is Financial Independence?
Financial Independence is when your investments pay for all your living expenses and you don’t have to work anymore. It is also sometimes called early retirement.
How much money do you need for financial independence?
The number varies depending on your current income and lifestyle. The average American needs about 1.5 Million dollars, but you can determine exactly how much you need to save using the 4 percent rule.
How do you achieve financial independence?
In order to retire early, you need to start spending a lot less than you earn. There are 4 basic steps to achieving financial independence: Set your goal, chose your lifestyle, earn extra cash, and cut costs.
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