FIRE: Financial Independence, Retire Early

Marc Smeehuijzen

FIRE (Financial Independence, Retire Early) is about being able to stop working before your retirement age at, say 67 years, because you have acquired enough money.

I found out about the FIRE movement in 2021, but the informative and funny Mr. Money Mustache was already blogging about it 10 years earlier, and the ideas behind FIRE are even older.

I was fascinated by the concept and did some online exploration that I’ll share here.

To become FIRE, you need to take three basic steps:

Step 1: Keep your expenses low

The lower your annual expenses, the quicker you can become FIRE. It’s therefore smart to find out how much money you need per year to live off, and then see if you can lower this. Think about the costs of your car, vacations, groceries, subscriptions, etc. The challenge here is to spent as little money as possible, and still enjoy life.

Another strategy to make early retirement possible is to increase your income. You should definitely try this, but this can be really hard, especially in the beginning of your career.

Step 2: Invest your surplus income

Once you make more money than you spend, you can invest the surplus and receive some returns. There are many ways to do this, but it’s good to keep in mind that all investments have a risk-reward tradeoff.

Some investment examples from low to high risk & reward:

1. Put money in the bank and receive interest
2. Real estate (buy a house)
3. Index funds
4. Stocks
5. Crypto

Putting money in the bank is the least risky option and you’re basically guaranteed some returns, depending on the interest rate. Interests rates however have been really low lately (in the US they have been under 2% for the last 14 years, even lower than the 2.6% average annual inflation of that period), so don’t expect much. On the upside, there is very little risk of losing money – only when the bank goes bankrupt, but this is rare.

Buying stocks or crypto can work really well… if you’re lucky! Unfortunately, predicting future prices is next to impossible, so chances are quite high that you will lose a substantial amount of money too.

Take for instance Tesla stock. If you would have bought these in early 2020 at $30 and then sold them at their peak in late 2021 for $400, you would have multiplied your money more than 13 times! However, if you had bought them late 2021 and then sold them early 2023 for around $120, you would have lost 70%!

The ups and downs for crypto are even more extreme. For example, you could buy bitcoin in 2016 for $400 and sell them 5 years later, in late 2021, for over $60.000, multiplying you money by 150! However, only 8 months later the price fell back to $20.000, losing two-thirds of your investment again.

What you want for the purpose of reaching FIRE is a decent return on your investment, without the risks getting out of hand. Both real estate and index funds live in this happy intermediate of risk and reward, and especially the latter one is popular in FIRE circles.

Index funds

An index fund (also sometimes called an ETF or Exchange Traded Fund) can be seen as a basket with (fractions of) all the stocks of an index like the S&P 500 or the Dow Jones. The performance of the index fund is the same as that of the index. Because your investment is spread over many companies this way (e.g. 500 in the case of the S&P 500), an index fund is less risky than buying stock of an individual company. On the down side, the potential rewards are also lower compared to the stock of particular successful companies at that time.

There are many different index funds out there and if you want to spread your risk as much as possible, you should get one that tracks many companies, in different countries, covering all kinds of industries like technology, finance, healthcare, etc. Some index funds track thousands of companies worldwide.

How much return to expect? Like with stocks, the performance of index funds in the short run is quite unpredictable. Some years the funds go up, and some years they go down. But let’s have a look at popular funds that tracks the S&P 500 index which traditionally is a good indicator of the US stock market as a whole. The 100-year average annual return of the S&P 500 (adjusted for inflation, including dividends) has been about 7%, so this would be the returns on your index fund.

Step 3: Keep going until FIRE

You’re FIRE at the moment when the annual returns on your investments cover your annual expenses. To determine how much investment you need for this, the FIRE community recommends to assume a conservative annual return of 4% (adjusted for inflation).

Now you can calculate how much money you need. For example, let’s say your annual living expenses are €30.000. In that case the investments needed to generate this amount per year, assuming 4% returns, would be €750.000 (4% of €750.000 is €30.000). In theory (if your future expenses don’t go up) you could live indefinitely on these returns.

€750.000 probably sounds like a lot of money, but there are situations when you need less. Let’s look at some possible scenarios.

Imagine…

• You’re 45 years old, you expect to reach 90 years, and you don’t mind using up all your money. In that case you wouldn’t need €750.000, but about €622.000.

• Let’s also assume you will receive a state pension of €19.000 per year when you reach 67 years, like many people do in The Netherlands (called AOW). Then your required amount would go down further to €493.000.

• Finally, imagine you also expect to get a €50.000 inheritance at age 50. Then the needed amount would go down to about €451.000 to become FIRE.

Now even in this last case you would still need almost half a million euros, and that probably still looks quite daunting. However, if you start consistently saving and investing early in life, with the magic of compound interest, you might get there sooner than you think.

For example:

Let’s say at age 20 you start investing monthly €100 in a S&P 500 index fund. Assuming your salary rises over time, you might be able to double this amount every five years. So at age 25 you invest €200 per month, at age 30 you invest €400 per month, etc. Assuming furthermore an average annual return of your index fund of 7% (see above), then this is how your capital would grow in the next 30 years:

By the time you’re 48 years old, you would have surpassed the required €451.000 in the above scenario and you would be FIRE. (Around age 51 you would be FIRE with the original €750.000 amount).

Admittedly, this all is still easier said than done. Your salary needs to go up over time in order to make the monthly investments and you have to keep your expenses low, but it might be more doable than first imagined.

Some more FIRE info:

• Mr. Money Mustache: One of the first FIRE blogs
• Financieel Onafhankelijk Blog: A Dutch FIRE blog for readers in The Netherlands
• True Stories of Investing: An accessible 45 min. documentary by online broker DeGiro on investing, including info on ETF’s

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