Hi new readers, welcome to retireinprogress!
This page is here to introduce you to FIRE: Financial Independence and Early Retirement.
It’ll be a long tour into the basic principles with links to external and internal resources, written in the form of questions and answers (F.A.Q.)
It should take you between 45 and 60 minutes to go through this introductory material.
I hope you’ll get inspired by that and start making steps toward your financial goals!
Let’s get started!
Table of Contents
- Q) Who the hell are you?
- Q) What is FIRE?
- Q) Is that something you just made up or is it an actual thing?
- Q) What is Financial Independence?
- Q) I don’t understand. I have some money in my bank, but what do you mean by “Wealth that generates income”?
- Q) Interesting. But before we move on, why should I want to Retire Early?
- Q) But I love my Job, why should I retire early?
- Q) But I don’t want to do nothing like retirees do, I’m young and I want to be productive! Why should I aim to early retirement?
- Q) Ok, good point. It’s all about having more options and freedom. Let’s get concrete though. How much money do I really need?
- Q) I’m lazy, tell me more about the passive investment strategy. How much money should I invest? How? What are the expected returns?
- Q) But wait… You’re telling me that stocks will always go up? What if there’s a market crash? How can you guarantee that stocks will go up forever?
- Q) Cool! So I just need to accumulate 25 times my yearly spending! How long does it take? Does it depend on how much I earn? Does it depend on how much I spend? It’s better to focus on increase earnings or lower expenses?
- Q) Wait, you said that saving is more important than earning and then you said that the only factor that matters is saving rate (S/E). Doesn’t that mean that saving and earning are both equally important?
- Q) Awesome, got it! What is take home pay? Is that my monthly salary? Yearly? Gross? Net?
- Q) What does Net Worth mean?
- Q) All these formulas and I’ve seen no actual number! How much do I need to reach Financial Independence if I make 60k per year, want to use the 4% rule and I spend 40k per year?
- Q) Whaaat? Is a Million ($, £, €, CHF) really enough??
- Q) That’s awesome, but why did you say that I should be living on 3-5% of initial nest egg while we just demonstrated that 4% is enough?
- Q) What do you mean by “high market valuation”?
- Q) What is the Sequence of Returns Risk?
- Q) So… it’s a 3.25% rule for everybody? Or a 2.5% (like Ben Felix claims)?
- Q) So why are you aiming to a 3.5% Safe Withdrawal Rate and a pretty high monthly target allowance (3500 Eur) and consequently high FU Money (1.2M EUR)?
- Q) Ok, please tell me more how should I invest my money. Which fund should I buy?
- Q) Ok. I think we covered a lot of the financial and psychological aspects of FI and ER, but I’m full of debts. What can I do?
- Q) But I don’t know how much money I do have now, what can I do?
- Q) But I don’t earn much, what can I do?
- Q) But I don’t know how much I spend per month/year, what should I do?
- Q) But I can’t cut my spending much, I don’t want to live like a poor or deprive my children and myself of the treats we deserve. What can I do?
- Q) But I’m in a relationship (or married) and my partner is spendy / doesn’t believe in this FI thing / doesn’t want to move to XYZ / wants to absolutely move to XYZ / Etc. What can I do?
- Q) But I have children, can I dream about FI?
- Q) But I live in a HCOL (High Costs of Living) area, what can I do?
- Q) Why Mustachian? Why Mustachianism? Why Mr Money Mustache? Why are mustaches so important?
- Q) What about housing? Should I buy or rent?
- Q) You keep talking about this “FIRE Community”, what do you mean? Is there some community-like forum or what?
- Q) It’s all turbo awesome, but let’s get back for a moment on the Early Retirement thing. I have some concerns. If you retire, you won’t be contributing to the economy anymore. Is that ethic for you?
- Q) I don’t buy it (your story)! I mean, you would not be working, not producing and still profiting from other people’s hard work… Is that ethic?
- Q) Yes, but you – yourself, your skilled self – would be out of the economic machine. And that’s unethical in my opinion. Don’t you think so?
- Q) Oook, I read all of this. What else should I do?
Q) Who the hell are you?
I’m Mr. RIP, an Italian who lives in Switzerland.
For what matters here, I’m also a FIRE seeker.
Q) What is FIRE?
Fire is a widely used acronym that joins two distinct but correlated concepts: Financial Independence and Early Retirement.
Q) Is that something you just made up or is it an actual thing?
This is going to be a 8.5k words post/page and it’s going to take a lot of your time, but if you’re curious and you’ve got a lot of extra time then invest a bit of it in reading about the history of the movement, written by Early Retirement Dude.
Q) What is Financial Independence?
Here’s the Wikipedia definition:
Financial independence means you have enough wealth to live on without working. Financially independent people have assets that generate income (cash flow) that is at least equal to their expenses.
To my surprise, the definition changed since last time I checked a couple of years ago. Previous Wikipedia definition:
Financial independence is generally used to describe the state of having sufficient personal wealth to live, without having to work actively for basic necessities. For financially independent people, their assets generate income that is greater than their expenses.
After another couple of years, Wikipedia definition changed again:
Financial independence is the status of having enough income (from investments, passive businesses, real estate, etc.) to pay for one’s reasonable living expenses for the rest of one’s life without having to rely on formal employment.
Anyway, FI means that your wealth generates income that is greater than your expenses.
Which in turn means that you have to know what’s your wealth, what income it generates, and what are your expenses.
Q) I don’t understand. I have some money in my bank, but what do you mean by “Wealth that generates income”?
Your wealth generates income.
Your bank account generates income too! It’s called interests. Yes, I’m talking about that 0.0000(…15 minutes later…)001%. Not that much, isn’t it?
As you may imagine, having money sitting in your bank account is not the smartest way to build wealth, because the interest is negligible, and always below inflation rate. So, even if you’re not withdrawing a Rappen from your nest egg, its purchasing power moves toward zero in the long term.
If you’d go cryonics for 1000 years with a million dollars in the bank and let compounding work for you, then you’d wake up really disappointed.
I’m sorry if Futurama convinced you otherwise.
So, how to setup this machine that generates income?
In a word: Investing.
Q) Interesting. But before we move on, why should I want to Retire Early?
Early retirement is just an option.
Financial Independence gives you options. Without FI it’s riskier to retire early from a career.
Let me ask you a question: what would you do if money were not an issue?
If your answer is “I’d do the exact same thing I’m doing right now, including going to work everyday at my current job“, then congratulations! You should keep doing what you’re doing and not care about early retirement 🙂
If your answer contains at least one of the following, you might want to take a closer look at Early Retirement: following my passions, spending more time with family and friends, travel more, volunteering, trying out new things, sleeping more and better, regret nothing on the deathbed…
Personally, I think that time is my scarcest resource, so my life is driven by a time economy and not a money one.
In order to remove money from the equation, I need to care about money a lot for a while.
Money is like oxygen: if you don’t have enough you should focus all your energy on it. Once you have enough, there’s no need to breathe more in.
Ideally, as Mr Money Mustache says, I would like to reach the point where:
I try to make all spending decisions as if the price were $0.00
And I make all work and income decisions as if the wage were $0.00
Q) But I love my Job, why should I retire early?
As I said, it’s just an option enabled by reaching Financial Independence. Having more options is always better than having less.
Nobody will criticize you if you keep working after you’re FI. As Mr Money Mustache says: work is better, when you don’t need the money. Please, find 28 minutes to watch his WDS 2016 video.
Being able to walk away at anytime gives you confidence, strength, negotiation power and more benefits.
It’s confidentially called “having F.U. Money“.
But there’s more: it may not depend on you. Assuming you’re relatively young and far from traditional retirement age today, remember that things
may will change in the future:
- On your side: changing priorities and interests with age.
- On your employer’s side: you may get fired, your boss could change, your company’s culture may change, your coworkers may change, your company may get acquired and so on.
- On the market side: your job may be automated out, your skills may go out of demand, there
maywill be a recession, your field may bubble out and so on.
- On the government side: official pension age
maywill step away, pension benefits maywill change, social security may disappear and so on.
- On the life side: you may need time away to be close to an aging parent, a family member, or a friend who needs help and so on.
In the end, it’s better if your work becomes optional.
Q) But I don’t want to do nothing like retirees do, I’m young and I want to be productive! Why should I aim to early retirement?
I don’t know many “traditional retirees” who do nothing and complain about that 🙂
Btw, I agree with you. And with John D. Rockefeller:
I can think of nothing less pleasurable than a life devoted to pleasure.
The problem is that retirement is a bad word.
It’s been introduced long ago, and has always been used for old age seniors that are being relieved from any assignment and can rest for their last few decades of their life.
Not my picture of retirement.
When I think about retirement I think about working on my projects with no externally imposed schedule that I do not approve. Plus, no profitability requirement. I want to work on meaningful projects without the need to generate any extra money, because I would already had enough.
Someone suggested calling it rewirement.
It’s not even a binary black/white thing, there’s a spectrum of options available for you:
- Take more prolonged breaks (sabbaticals, mini retirements, gap years) from work. Look at this amazing TED talk.
- Reduce your working hours and go part time.
- Work seasonal jobs.
- Become a single income household.
- Go back to school and try to change career.
- Take a lower paying but more fulfilling job.
- Start your own company with less pressure about money.
Again, retirement is a very bad word, but we don’t have a better one at the moment.
It’s all about having more freedom. Options give you freedom. Financial Independence gives you options.
Using the wonderful words of Karsten, Big ERN:
It all boils down to opportunity cost. When I was young, opportunity cost fit the economics textbook definition: Fun activities have the additional cost of lost wage income. Now, money is more abundant and time is becoming scarce. Opportunity cost now works the other way around; the corporate rat race has the steep price of time away from my wife and daughter, time away from other loved ones.
Q) Ok, good point. It’s all about having more options and freedom. Let’s get concrete though. How much money do I really need?
It’s not about money, it’s about income and spending. To be fully FI means that your wealth generates income which is greater than your expenses.
To make your wealth produce an income you need to invest it. There are tons of investment fields and strategies as complex and time consuming as you want, but unless you actually enjoy it and are willing to become an active skilled investor it doesn’t have to be that complicated.
The main investment strategies used by many FI seeker are two: rental properties and passive funds investing.
The rental properties strategy means you buy properties (flats, houses, condo, offices, terrains…) and rent them out. The income is the net rent minus expenses, minus taxes, minus maintenance, minus mortgage, minus other things.
The passive funds investing strategy means you buy&hold low cost index funds (stocks and bonds). The income is both assets appreciation and profits (dividends).
Bloggers that adopted passive investing strategy are: earlyretirementextreme, mrmoneymustache, jlcollins, millennialrevolution, rootofgood, earlyretirementnow, livingafi, getrichslowly, madfientist, budgetsaresexy…
There are other strategies too, like p2p lending, startup investing, active stocks/options investing, online businesses and so on.
There’s no right or wrong strategy, it’s a matter of personal taste. Rental properties is more active and less volatile, while passive investing is fully passive but more risky.
It’s also market specific: some locations favor one strategy over another due to taxes, supply and demand of some specific kind of properties, rent market prices etc.
It doesn’t even have to be either black or white, most of the rental folks invest in stocks and bonds too. Like the frugalwoods.
Q) I’m lazy, tell me more about the passive investment strategy. How much money should I invest? How? What are the expected returns?
Again, it depends on your estimated spending needs for the remainder of your life, and your personal risk tolerance.
Let me first add a disclaimer here: William Sharpe, an Economic Nobel prize winner with a financial indicator named after him, once called retirement spending “the nastiest hardest problem in finance“.
Predicting how much you will need during your remaining years (and find a financial strategy to prepare for that) is extremely complicated even for a standard 65yo retiree. Imagine how hard it is for a young retiree in their 30s or 40s!
Anyway, let’s assume you have a rough idea of how much you’re going to spend each year in retirement. A simple model is constant initial yearly spending, adjusting the allowance with inflation over the following years. We could call it constant purchasing power. Your current annual expenses are usually a good guess of your target retirement purchasing power.
Of course you may plan to move to a lower cost of living area, and that’s called geo arbitration. Of course your expenses may go up (want to travel more), or down (no need to spend money on daily work commutes and fancy work clothes), or be strongly irregular due to one-off spending events (funding your son’s college and new car) or recurring expenses over a limited period of time (feeding your 4 and 10 years old children till age 18). There are tons of retirement calculators (firecalc, cFIREsim, portfolioCharts, networthify) that let you model your specific situations, but for the sake of simplicity let’s assume you have constant yearly expenses (inflation adjusted) and let’s call that X.
Again, it’s an oversimplification, but not a bad one.
In order to generate X each year, indefinitely, using a strategy based on passive investing in index funds, your total investments should be a multiple of X, i.e. N times X. And your strategy could be to withdraw X from your investments (inflation adjusted) at the beginning of each year. The actual withdraw strategy can be more complex (like variable percentage withdrawal), and legislation dependent due to tax implications and accounts accessibility before pension age.
That multiplier N depends on your personal risk aversion, but we have a lot of data to help you with it 🙂
SPOILER ALERT: you should pick a multiplier in the range 20 – 40. Or, as it’s usually expressed in the FIRE community, you should count on living on 2.5-5% (inflation adjusted) of your initial nest egg each year.
That percentage is called Safe Withdrawal Rate (SWR).
For starters, let me introduce the 4% Rule. It all started with a paper published by Bill Bengen 1994, and a more academic follow up by three professors at Trinity University (Texas) that produced another paper in 1998 that is known under the name “The Trinity Study“.
The two papers studied the behavior of several simulated portfolios, with different stocks/bonds allocation, over every time period of 15-30 years in the past (data from 1926 to 1997) subject of inflation adjusted yearly withdraws.
Both papers concluded that a 4% SWR has a ~100% success rate on a portfolio with 75% stocks and 25% bonds over a 30 years period. Go read the full study if you like.
The 4% Rule is a pioneer study in the field of income generating portfolios, and after 20 years it’s aging a little bit. Not for the original authors though. There’s been an update in 2011, with more data at hands (and two major financial crisis) which essentially said “the 4% rule still holds“.
Bill Bengen too, in a 2017 reddit AMA confirmed that the 4% rule still holds. He actually raised the bar, claiming that “the 4% rule is actually the 4.5% rule“.
That would mean you need a multiplier factor N of 22 – 25 and you’re good to go. In fact, if you have invested 25 times your yearly spending, 4% of it is exactly your yearly spending.
Search on the internet!
Literally every FIRE blogger has a post about the 4% rule! Very likely an optimistic post about it, giving the rule for granted 🙂
Q) But wait… You’re telling me that stocks will always go up? What if there’s a market crash? How can you guarantee that stocks will go up forever?
All I can do is look at the historical data. Throughout human history, we’ve experienced unlimited growth. Since recorded economic data (somewhere around 1780), we’ve experienced an average 10% yearly growth, inflation adjusted.
Of course, individual companies can go belly up (like Monte Dei Paschi di Siena, an Italian Bank that lost 99.9997% in 11 years).
Also an entire market can experience big losses in a short period of time, like the US great depression in 1929-1933, and more recently the dotcom bubble (2000-2002), the great financial crisis (2008-2009), and the Corona Virus flash crash (Feb-Mar 2020)… but over long periods of time the growth trend looks very stable.
Take a look at the 30 years annualized average returns of S&P 500, a stock index tracking the biggest 500 US companies based on their market caps (image from awealthofcommonsense):
That means that even in the worst 30 years period of recorded history (30 years starting right before the 1929 crisis), the average yearly return on stocks had never been below 8%, and usually above 10%.
The stock market grows. It always does.
That’s because human ability to create value grows.
Yes, that means believing in somewhat “infinite growth”, in capitalistic principles.
What are the alternatives? That the entire world will collapse and civilized society declines into post apocalyptic scenarios? Well, do you think anything else would matter then? Do you think your job will still be there in that case?
The beauty of this formula is that in the extremely rare cases where it would fail, no other regular solution would work, i.e. you’ll be fighting for food and weapons 😉
Q) Cool! So I just need to accumulate 25 times my yearly spending! How long does it take? Does it depend on how much I earn? Does it depend on how much I spend? It’s better to focus on increase earnings or lower expenses?
Awesome questions! Of course it depends on both! Id’ actually say it depends on Earning, Saving and Investing.
You need to get good at all of the three main Pillars.
Before you complain about you not earning much, let me tell you this: FI is achievable at any income level. So I’d classify earning as a bronze medalist in this ranking.
Among the other two, I’d classify investing as silver medalist, while the gold goes to… saving!
I’ve never seen someone who consistently spend less than they earn go broke. Not a single person. On average, good savers are those who are willing to take more risks, face adverse market conditions, and handle life curve balls.
Mind that I’m talking about saving, not spending. Saving is not independent from earning. The more you earn, the more you save.
Spending, on the other hand, is an independent variable. If we consider the triad Earning, Spending and Investing, I’m a bit more reluctant to give spending the gold medal.
I know plenty of people (essentially everyone in the neighborhood I grew up in Rome) who cut their expenses down to the bones but still struggle to make ends meet. If your income is too low, even with essential spending you might struggle to grow your wealth.
So yes, you should focus on growing your income too, but that should not be your only goal. You can build a career, launch your business idea, freelance, create value. More on this later 😉
Once your income covers at least your expenses, focus more on saving, i.e. cutting down your expenses.
The less you need to live, the easier it will be to reach freedom. That’s not rocket science, so many amazing people said that before me. Like good old mustachian David Henry Thoreau once said:
A man is rich in proportion to the number of things he can afford to let alone.
David Henry Thoreau
Low expenses have a double impact on your road to FI:
- It lowers the income your wealth needs to generate, i.e. it reduces your Target Net North to retire early.
- It increases your savings, i.e. the growth of your wealth. You’ll reach the target earlier.
We’ve already shown how saved money sitting on a bank account doesn’t grow on its own. You need to invest them and benefit from compounding over time. So, save a lot and invest your savings! Do not spend money on useless stuff:
Money is a terrible master but an excellent servant.
Compounding means that over time your investments will grow exponentially, not linearly. The early you start investing your money, the better.
About time needed to reach FI (25x yearly spending): under some assumptions (predictable and constant investments growth, predictable and constant inflation rate) it only depends on your saving rate, i.e. how much you save divided by how much you take home.
A picture is better than a thousand words (thanks to networthify):
If you save 50% of your take home pay (and assume 7% inflation adjusted yearly returns on your investments) it will take you only 15 years to reach FI from scratch.
Ok, assumptions are debatable, but it’s indeed true that given the same saving rate, two FI seeker starting from scratch will reach FI the very same day. It doesn’t mater if one of them makes 40k a year and spend 20k while the other makes 200k and spend 100k.
If you save 70% of your take home pay (pretty aggressive, but that’s more or less my target):
I also assumed more conservative returns on investments (6%) and the result is… 8.5 years!
What about saving 15% of your take home pay?
Welcome to traditional retirement! It will take you almost 40 years to reach FI.
Did you notice that some bar has a country name on it? It indicates the average household saving rate (in 2008) for that country. Well done India! Booo UK!
Did you notice how poorer countries with lower salaries are saving more than richer countries like US and UK? Did I already say that saving is more important than earning and investing? 🙂
Q) Wait, you said that saving is more important than earning and then you said that the only factor that matters is saving rate (S/E). Doesn’t that mean that saving and earning are both equally important?
They’re fractionally equally important, but not in absolute value.
if you aim to save 50% of your income, spending 1000$ more is not compensated by earning 1000$ more, but by earning 2000$ more!
If you aim, like I do, to save more than 2/3 of your income, increasing your monthly spending by 1000$ is compensated by earning 3000+$ more!
Do not fall into the trap “I got a 500$ raise, I can spend 500$ more per month!”. Yes, of course you can, but your saving rate will be lower and you’ll reach FI later. Savings would be the same, your wealth would grow at the same speed, but you’d need more wealth to fund your inflated lifestyle. Read this amazing article about income thinking vs expense thinking.
Which brings us to the topics of avoiding lifestyle inflation, minimalism, frugality, self reliance, consumerism, ethic, psychology, philosophy and a lot of other interesting stuff we won’t discuss here in this FAQ.
I didn’t write much about these topics on my blog so far, I would like to explore them deeply in the near future. If you’re interested, I suggest you to read books like Early Retirement Extreme, Your Money Or Your Life, Walden, Essentialism, The Daily Stoics, Work Optional, and Meet the Frugalwoods (that I didn’t read yet though).
Q) Awesome, got it! What is take home pay? Is that my monthly salary? Yearly? Gross? Net?
By take-home pay I mean the net amount of money that goes into your wealth every year.
I consider part of my take home pay my net salary (sometimes hard to calculate due to deferred income taxes), my Swiss pension Pillar 2 contribution and my employer’s match, my investments profits (dividends, but not capital gains).
I don’t consider part of my take home pay assets growth or loss, and Swiss pension Pillar 1 contribution.
Why do I consider Pension Pillar 2 and not Pillar 1? Because Pillar 2 contributions end up in a pension account I can somehow control and in many cases withdraw fully. It’s actual money to my name. Pillar 1 is not money on some bank account to my name. I know I might receive some benefits one day (here‘s how to estimate them), but I’m not counting on that and I’m not adding my Pillar 1 to my net worth.
More about Swiss Pension system here.
Q) What does Net Worth mean?
Your Net Worth is the total sum of your assets minus your liabilities. It’s a snapshot of your wealth.
I wrote about Net Worth here.
Here you can find the first post on a series about how I track my finances with spreadsheets.
Q) All these formulas and I’ve seen no actual number! How much do I need to reach Financial Independence if I make 60k per year, want to use the 4% rule and I spend 40k per year?
Ok lazy friend, let me do a couple of multiplications for you 🙂
if you want to live on 40k per year and you want to use the 4% rule, then you need 40k*25 = 1 Million.
This amount is sometimes called FU Money 🙂
How long would it take if starting from zero and assuming a 6% investment growth? You’re saving 20k out of 60k, which is 33% Saving Rate. According to networthify you need 23.4 years.
Remember that I’m using take-home pay, not gross salary. And I’m considering retirement expenses, which includes taxes on your withdraws/income.
Q) Whaaat? Is a Million ($, £, €, CHF) really enough??
If you can live on 40k per year, yes, it is 🙂
For example, 40k Euro is a pretty decent salary in Italy (in 2018) that’s almost twice the average household net-adjusted disposable income per capita of USD 26k (according to OECD)
Anyway, if you go around asking questions like “can I retire with X millions?” you probably cannot, as my friend Jacob says 🙂
If you’re a math nerd like I am, you’ll soon notice that the math behind FI is very simple and some implications are really funny. Look at this: using the 4% rule, every one off expense translates to a daily/monthly/yearly flow and every recurring (forever) expense translates into an invested amount.
For example, thinking about spending 5k on your next vacation? Well, 5k invested becomes 200 per year, forever. Or 16.66 Per month.
For every 30k you have invested, you own a machine that generates 100 per month, forever.
Every 300k –> 1k per month.
Mind blowing, isn’t it? 🙂
On the reverse: thinking about a gym membership? 100 per month? Cool, you need to save and invest 30k more to pay your gym forever. That’s the true cost of recurring expenses!
In these terms, every persistent lifestyle upgrade has a lifetime cost attached to it, and every lump sum translates into a lifetime monthly allowance.
Isn’t it cool? 🙂
Q) That’s awesome, but why did you say that I should be living on 3-5% of initial nest egg while we just demonstrated that 4% is enough?
Because the 4% rule it’s not a panacea! The 4% rule has its own limitation:
- It’s limited to US market.
- It only uses stocks and bonds data since 1926
- Time intervals of one year are too coarse.
- It considers only a 30 years horizon, while early retiree may need 40-50-60 years of income.
- A sample is considered successful if the investment balance at the end of the 30 years is barely positive, while a retiree might want to aim to capital preservation (leaving inheritance to children, donating to a cause)
- Initial stocks valuation is not taken into account.
- uses a rigid (fixed amount, inflation adjusted) withdrawal scheme.
Luckily, in our FIRE community we have modern economists studying the same problem under the constraints we care about. The deepest study made so far has been done by Big ERN from Early Retirement Now.
23 38 posts (so far) Safe Withdrawal Rate series he analyzed the behavior of several portfolios up to 60 years on a monthly time frame, starting in different stock market valuations, subject to different withdrawal schemes and using data from 1871 to 2016.
He concluded that the absolute bulletproof SWR is 3.25%. I strongly encourage you to go read the whole series.
He also openly criticized the Shockingly Simple Math by MMM in his 22nd episode, stating that if you pull the trigger as soon as you reach 25x your spending you’re more likely to start your ER journey in a High Market Valuation and too much exposed to Sequence of Returns Risk.
But Big ERN is not the most pessimistic financial expert around. Take a look at this video by Ben Felix:
He claims for an early retiree that wants to stick with a constant-dollar withdrawal strategy, the SWR they should stick is ~2.5%. Ouch.
Watch also this other video of him:
So… it’s a bit more complicated 😉
Q) What do you mean by “high market valuation”?
Before I start, mind that this is a controversial topic. One of the most commonly accepted market model is the Random Walk, i.e. stock market prices evolve randomly and cannot be predicted. Future gains/losses don’t depend on past gains/losses.
This model is consistent with the efficient-market hypothesis that states that asset prices fully reflect all available information, i.e. it is impossible to “beat the market” consistently.
Problem is: there are studies who show that markets aren’t random. They are not stateless. They’re still almost impossible to predict but they follow cycles and over a long period of time they can’t drift much and tend to get back on track. That’s called Mean Reversion (take a look at this amazing post by Big ERN about it).
Which means that you can say “today stock prices are pretty high“, which wouldn’t make sense under the random walk hypothesis.
So we have indicators, parameters that tell us how expensive is a stock (or an asset in general) today. The most famous is the (Nobel prize winner) Shiller P/E Ratio, also know as Cyclically Adjusted Price to Earnings ratio (CAPE) or PE 10, since it’s cyclically adjusted over a 10 years window. It tells us what an asset costs in function of average earning it produced over last 10 years.
A value of 20 for example means an asset pays its price in 20 years. If you buy a house and rent it out for 5% of its price per year, you have an asset with P/E 20.
The CAPE can be extended from a single asset to an index, simply as the weighted average of the individual CAPE. CAPE has peaked right before past stock market crisis thus could be a predictor (correlation > 0) of a potential market crisis.
Anyway, as Big ERN study concluded, in the recorded financial history, long term stocks returns have been lower when starting at a higher CAPE value.
Q) What is the Sequence of Returns Risk?
Let’s assume you have 2 assets: one that performs +100% on day one and -50% on day 2, and one that does the opposite: -50% on day one and +100% on day 2. After 2 days they’re both back at its original value, even though they have different sequence of returns.
The sequence of returns matters a lot if you’re withdrawing from your asset.
Let’s say the 2 scenarios above are 2 early retirees with a nest egg of 100, withdrawing 4 each year at the beginning of the year.
Scenario 1: 100 becomes 96 after year1 withdraw, then becomes 192 after year1 +100% return, then becomes 188 after year2 withdraw and finally it becomes 94 after year2 -50% return.
Scenario 2: 100 becomes 96 after year1 withdraw, then becomes 48 after year1 -50% return, then becomes 44 after year2 withdraw and finally it becomes 88 after year2 +100% returns.
The sequence of returns matters, because if you have to withdraw in low market valuation you’re forced to sell assets at low prices.
That’s called Sequence of Returns Risk, and it says that once you start living off of your investments, hitting bad returns at the beginning of your retirement is the major financial risk.
Q) So… it’s a 3.25% rule for everybody? Or a 2.5% (like Ben Felix claims)?
As I said, it depends on your personal risk tolerance.
There are still strong supporters of the 4(+)% rule, like the original authors of the study (Bengen and the authors of the Trinity study), many modern economists and financial planners like Michael Kitces and many bloggers like Jim Collins, the Mad Fientist, Root of Good (with some adjustments), Millennial Revolution (with some adjustments), Mr Money Mustache (with some safety margins), ESI Money (with some safety margins), Living a FI (with a Oh Crap and Oh Shit guardrails) and so on.
Did you notice that almost everybody has their personalized version of the 4% rule?
That’s because 4%, 3.25%, 4.5% are just numbers and “the 4% rule” is a rule of thumb.
And, most important, Money and Confidence are interchangeable (please, take your time to read this amazing MMM post).
if you’re here, reading my blog, good chances are that you’re way smarter, curious and skilled than the average. There’s no way you’re not going to earn a dime for the rest of your life (like the 4% rule assumes) just doing whatever makes you happy! It’s way more likely that the opposite will happen: first retire, then get rich!
Q) So why are you aiming to a 3.5% Safe Withdrawal Rate and a pretty high monthly target allowance (3500 Eur) and consequently high FU Money (1.2M EUR)?
Well, because I’m always erring on the side of pessimism. Because I’m playing super safe (and I probably lack some confidence!). In 2020 I lowered the SWR to pi (3.1415…).
I also have so many variables I need to model like:
- What’s the impact of one or two children on expenses
- How many of our current expenses are going to disappear in ER? How many new expenses are going to appear?
- Where will we live once we reach FI (which actually impacts FU Number)? Do I really want to retire in Italy?
- Do I want to fully retire or keep earning money?
- Do I want to semi-retire, work part time, take mini retirements or only pull the trigger if I’d reach bulletproof 100% safety in every reasonable scenarios including Zombie Apocalypse?
I used to aim to last one: super safety. Maybe even falling into the One More Year syndrome. But over time I moved to a more holistic approach with work, life, and retirement. I’d rather aim to the stars, setting unrealistic goals, and then realize that 505 of it is still amazing than make tight goals and realize once reached they’re not enough.
As you can see… I’m sorry, I don’t have a definitive answer about this question! I hope I showed you the problem from so many angles so that you can take your own decision 🙂
Q) Ok, please tell me more how should I invest my money. Which fund should I buy?
Here’s where things get slightly more complicated (but not that much, it’s not rocket science).
I’ve written a lot about it, go follow my investment series. Start from the basics, and move on to financial investing. Learn about the funds investing world and the ETFs. Write your own Investor Policy Statement and start investing.
See you later!
Q) Ok. I think we covered a lot of the financial and psychological aspects of FI and ER, but I’m full of debts. What can I do?
You’re American, right? 🙂
I’m not very good at giving debts advices since I never had one. It’s like asking to a non smoker (like me) how to quit smoking. I have it embedded, the best suggestion I can give to you is to “never get one”.
Anyway, this topic has been covered by tons of resources, especially by US bloggers and traditional television “financial gurus”. Simply stated: prioritize debts repayment over everything else. Every amount put toward debt repayment is an investment with returns equal to the debt interest.
Please note that my advice could lead to considering investing instead of repaying debts, which is similar to leveraged/margin investing, which is something I don’t recommend. Having zero debts, even low interest debts, gives you the peace of mind that keeping a 3% debts while investing in a 5% expected return fund simply doesn’t.
FI might still be a good guiding light, but you should focus on the basics now. Get rid of debts. It’s like wanting to run a marathon without having ever run 5k. Focus on running 5k now, the marathon can wait.
Q) But I don’t know how much money I do have now, what can I do?
Yes, back to the basics. The marathon, right?
In the amazing book Your Money or Your Life, you will find that financial awareness comes in steps. First step is Financial intelligence, which essentially means that you know where you financially are.
Take time to calculate your Net Worth and monitor it over time.
I’ve written about it in this blog several times, go read my posts:
And if you want to know how I myself track my finances, take a look at the Spreadsheet series. Here’s first post on the series, start from this one:
Q) But I don’t earn much, what can I do?
I think we’ve already covered that in this FAQ, right?
Anyway, ok, you want to know how to increase your earnings.
First of all, focus on your career. Which means: hard work. No shortcuts, sorry. You need to get your hands dirty for a long time, but for a noble reason: get out of the rat race as son as possible 🙂
That’s how I solved my internal conflict: “isn’t a gardener happier than a CEO?“. Well, probably yes, but the gardener has to keep being a gardener and earning their tight salary for the rest of their life, while the CEO could just do it for a couple of years and then do whatever they like for the rest of their life without caring about earning a Rappen or not!
Anyway, there are much better career motivator/coach/guru than me on the internet. For long term things, like career and finances, I’ve always preferred focusing on fundamentals, not on methods.
I’ve been cultivating creativity and curiosity which in turns they’ve helped me building tech skills and soft skills. Theater acting gave me confidence, very useful in any kind of negotiations and public speaking.
Passion for games and videogames improved my problem solving skills and made me write tons of lines of code since age 10. I get inspired by amazing people and try to follow their suggestions.
I still spend shitload of hours everyday reading, studying and practicing, i.e. trying to improve myself.
It’s a long term game.
Yes, I know, these are not the concrete tips you wanted to hear. Sorry about that, again.
Start a side hustle, whatever.
Q) But I don’t know how much I spend per month/year, what should I do?
Part of the Financial Intelligence phase of your financial journey is to be aware of how much you take home, how much you spend and how much you have right now.
Usually income awareness is simple. If you’re working for someone else you probably get a paycheck.
You may also get one or more of the following: pension contributions, health care contributions, bonuses, 13th month, 14th month (in Italy), stocks, stock options, other benefits like transportation allowance and so on.
You may have other source of income like rental properties, investment profits, sales proceedings, small side businesses income and so on.
Anyway, summing all of your incomes up should not be that complex.
Spending awareness is more complicated though.
First step of spending awareness is tracking total expenses over time. I recommend doing that for at least a full year so that any seasonal expense can be factored in. That should be relatively simple if you use a limited number of bank accounts and credit cards.
This first step tells you how much you spend, in total, per month/year. It’s enough to help you getting a picture of your financial health: income, spending and saving rate.
Second step consists of categorizing expenses and tracking them by category.
This step is necessary to understand where your money goes and it’s enough to start taking concrete actions like detecting areas where you can cut expenses or splurge more.
Third step is defining a budget.
Which means deciding up front how much you’re willing to spend on each category for each spending cycle. Some expenses have a monthly cycle (housing, transportation, utilities, restaurants and so on) while others may have a yearly cycle (travel, house repairs, big purchases and so on). A budget should take into account that.
I personally don’t do the third step. We’re saving 60-70% of our take home pay, which puts us in the indigo bucket in Trent’s saving rate spectrum and in the gold bucket in MustachianPost’s saving rate index. I’m more than comfortable with just monitoring and keeping a loose eye on our expenses in categories that we perceive as not strictly necessary.
You can take a look at my Net Worth document, where you will find our actual expenses and categorization over time. Feel free to copy the structure if you want.
I still recommend you to define a budget if your saving rate is below 30% and you to aim to reach FI somewhere before traditional retirement age.
Q) But I can’t cut my spending much, I don’t want to live like a poor or deprive my children and myself of the treats we deserve. What can I do?
Don’t put it as if every single expense of yours is inevitable. Truth is that almost each one is a choice. It all boils down to choices, priorities, trade offs, short term vs long term, instant gratification vs delayed gratification, fear, keeping up with the Joneses and YOLO.
In the end it’s a matter of personal values. I’m a frugal minimalist, even though I had to come down to compromises once I decided to start a family. I used to live with 500 Euro per month in Italy, now I’m trying to keep expenses below 4k CHF in Switzerland.
I get personal satisfaction when I don’t spend money or when I spend as less as I can.
I experimented zero spending for 2 weeks. I’ve been bike traveling in France with less than 10 Euro per day. I’ve been voluntary living with as less as I can for a while, practicing voluntary poverty.
I like Stoicism, let me introduce Seneca to you:
Set aside a certain number of days, during which you shall be content with the scantiest and cheapest fare, with coarse and rough dress, saying to yourself the while: ‘Is this the condition that I feared?’
I find it spiritually fulfilling on its own, but I’m wired this way and you may not be like me.
Anyway, frugality is not a bad word or a synonym of being cheap. Frugality is putting your money on what gives you value and cutting as much as possible on everything else.
Frugality is efficiency. Money is life energy collected, like a battery collects electric energy. That treat you “deserve” today is costing you the time you spent to produce the money it costs. Be efficient with it and spend it wisely!
And, by the way, if you think about the best moments in your life you may realize that many of them don’t involve purchases but people, and they don’t cost money, but time.
Time is your scarcest resource!
Still not convinced?
Read Trent Hamm (The Simple Dollar) on not buying things, questions you should ask yourself before a purchase, Frugality and long term financial success, wealth and happiness, the 30 days rule and the 10 seconds rule.
Q) But I’m in a relationship (or married) and my partner is spendy / doesn’t believe in this FI thing / doesn’t want to move to XYZ / wants to absolutely move to XYZ / Etc. What can I do?
That could be the main blocker. There’s no easy cure for that.
You should talk to your partner and see whether the two of you can find a common ground. Don’t focus on short term details, show them the big picture. Show them the lost opportunity cost of spending money on something that doesn’t improve your life in a long lasting manner.
Q) But I have children, can I dream about FI?
That’s totally not a problem 🙂 the FI community is populated by a lot of families with children.
Yes, it’s definitely going to take longer and be harder, but nothing is preventing you from achieving the goal. Except fear, in several dresses: fear your kid won’t poop happily without the best diapers, fear he or she won’t sleep without the latest and most comfortable baby cradle, fear that without the latest and most expensive toy he or she won’t be happy and so on.
Strangely, nobody fears that the baby could miss you while you’re both working very hard to buy stuff he or she doesn’t actually need.
There’s also a fast track to super parenting: reach FI before becoming a parent. Like MMM, the frugalwoods and many others did.
… and like we almost did, getting relatively close to FI before Baby RIP is born 🙂
Q) But I live in a HCOL (High Costs of Living) area, what can I do?
Geo arbitration is another hot topic.
There are strategies to accept it and strategies to fix it.
You can accept the situation, i.e. accept that you want to keep living in that area, and work longer or harder to build a money making machine that will produce more income.
You can also evaluate moving to a cheaper location within your city or to a cheaper city within your country or to a cheaper country. Geo arbitration can be exerted on any scale.
Mind that very HCOL areas are usually expensive thanks to business opportunities. If you won’t have to work anymore I guess you could easily move to cheaper locations without losing much quality of life.
Mind also that suddenly retiring after years of 9 to 5 routine could be a drastic change to your life, even if it’s for a good cause. Add to that that you’re throwing you and your family away from known territory. The chances of psychological failure for your early retirement might increase. Read the story of Joe, my fellow Hooli colleague, that failed at geo arbitration.
We, the RIPs, are facing this dilemma too.
Anyway, this is a very personal issue and there are not generic decision making resources on the topic.
We’re not doing enough research about geo arbitration, since we consider existing relationships (family and friends) – and the ease of creating new ones – top priorities. We are not considering – at the moment – anything different from Italy or Switzerland since we have strong social circles in our home country (Italy) and in our country of residence sing 2012 (Switzerland).
But since social bonding is what we crave for, we don’t exclude that if we could reproduce our ideal community somewhere else in the world we’d be all in (Transilvania? Canary Islands? Andalusia? It has to be sunny too!).
Anyway, don’t put as “I happen to live in a HCOL area, so I can’t reach FI“.
It’s always a matter of choice and priorities.
Say instead that “I live in a HCOL area now and I got used to this quality of life. I know I need to work 10 years more to reach FI here but for now I prefer to work more than move to the countryside and stop working 10 years earlier. I prefer to give my children higher quality education instead of spending more time with them. I prefer to have more choices between movie theaters, instead of having more time to watch movies”
It’s always a matter of choice and priorities.
Take your responsibilities, be a mustachian!
Q) Why Mustachian? Why Mustachianism? Why Mr Money Mustache? Why are mustaches so important?
Well, Mr Money Mustache is one of the early bloggers and he coined the term and we kind of like it.
But if you think about it…
Q) What about housing? Should I buy or rent?
Another very hot and debated topic! This is probably the one that heats and splits the FIRE community the most.
There is also an entire world of alternative living experiences: Jacob, living in a RV, the Van Life movement, the Tiny Houses movement and so on. They’re too extreme for us, unsustainable in the long term.
My personal opinion is that if you plan to stay in the same physical place for X years you should buy, otherwise you should rent.
How much is X? Well, it depends on the local housing market and taxes. It can range from 5 years to infinity. I don’t think it’s wise to buy a flat/house/apartment in any case if you don’t plan to spend at least 5 years living there.
Ok, there are few exceptions like if you are an expert in the housing market and you smell an investment opportunity. Or if you have insider trading information on the local government planning to build fast trains between your candidate house location and the closest airport that would double the price of your apartment once the news is public… but these are just rare exceptions.
Q) You keep talking about this “FIRE Community”, what do you mean? Is there some community-like forum or what?
When I refer to the FIRE community I refer to people aiming to Financial Independence and/or Early Retirement. Since it’s been a while since I started blogging and reaching out for like minded folks, I know quite a lot of people who I consider part of the community.
There are facebook, twitter and other social media based communities with public and private FIRE groups. I’m not very active there though.
There are also conferences and meetups. There’s FinCon, Chautauqua (Ecuador and Europe), the BENL meetup (Belgium and Nederland) and the FIWE (Financial Independence Week Europe)
See you around, maybe? 😉
Q) It’s all turbo awesome, but let’s get back for a moment on the Early Retirement thing. I have some concerns. If you retire, you won’t be contributing to the economy anymore. Is that ethic for you?
It’s not true, I will be contributing to the economy: I invest money, I own businesses, I’m already contributing to the production of goods and services (twice for now, since I’m also working).
I’m not an avid consumerist though. In that, I’m proud of not contributing to the economy much!
The economy is made of supply and demand though. I’ll definitely be contributing to it in Early Retirement by improving the supply of goods and services.
Now that I think about it, there are very few ways one wouldn’t “contribute to the economy”. Even if you do nothing and let your money sit in the bank then you’d be giving your bank money to lend out and you’d be helping them make more money (almost for free). I guess the only way to not contribute to the economy would be by withdrawing your cash in banknotes and keeping them under your mattress!
I’m investing in the stock market, in thousands of companies. You buy something from Amazon? Thank you dear customer, I own a piece of it! You just purchased a new Ferrari? Thanks again, I own a piece of that too! Do you drink Coca Cola? Thank you so much!
Q) I don’t buy it (your story)! I mean, you would not be working, not producing and still profiting from other people’s hard work… Is that ethic?
I’m not concerned about that.
With the amount I have invested (March 2018) you can easily buy, renovate and start operating 3-5 bars in Italy without having banks involved. With some debt leverage I could easily open 10+ of them.
I could have chosen to own 10 bars instead of investing small fractions in thousands of companies. That would have been a very literal implementation of the Barista FI concept!
Anyway, would owning a chain of locals still be considered work-unethical?
I’d be creating jobs, satisfying customers, moving goods, cashing profits but also being accountable for losses. Although it would be extremely cool to own 10 bars, why is that considered being active while passively owning small pieces of thousands of companies is not?
I’m contributing to the above mentioned macroeconomic effects (creating jobs, satisfying customers, “moving the economy”…) in the very same way!
P.S. Barista FI is a semi retirement model, where your wealth generates less income compared to Fully FI, but with the small extras coming from a lower paying (but supposedly more fulfilling and part time) job you cover your expenses.
Q) Yes, but you – yourself, your skilled self – would be out of the economic machine. And that’s unethical in my opinion. Don’t you think so?
I feel no duty whatsoever to use my skills in ways someone else desires.
Luckily we don’t live in a totalitarian regime and we have a lot of freedom, and by the way I don’t think I’ll be wasting my skills by not working my regular 9 to 5 job.
Today I’m earning a generous amount of money by working for Hooli, a gigantic tech corporation, doing something very very small within Hooli’s grand plan. I sincerely like my company, my office and my coworkers, but when I watch myself from above I see that what I’m doing has no big impact on the greater good, and thanks to that I lack a strong feeling of accomplishment.
To put that into perspective, from this blog – which is a very part time effort – I’ve received dozens of emails and hundreds of comments that showed me that someone is really benefiting from my writing.
Would it be more ethical to keep doing something that I perceive as low impact for the world but that moves a lot of money, or something that helps people while potentially not moving a Rappen?
And it’s not just “writing”, I have so many other desires and passions and who knows how many other interests will show up when I’ll free up a lot of time!
I bet I’ll be using my skills in Early Retirement waaay better than I’m doing right now 😉
Q) Oook, I read all of this. What else should I do?
I can’t believe you’ve reached the end of this page!
First of all, let’s celebrate, It’s been a very long journey! Here’s your cake:
Second, if all this material hasn’t stimulated your curiosity then you’re not curable, I’m sorry 🙂
Welcome to retireinprogress 🙂