What are the key metrics to determine if you have reached financial independence and can retire early. How major stock market losses can derail early retirement plans and what to do about it.
In this episode you’ll learn:
- What is the FI/RE movement and why is Suze Orman concerned about it.
- What is the simple formula to determine if you can retire early.
- How large stock market losses can lead to early retirement ruin and what to do about it.
Early retirement is something many of us dream of and would love to accomplish. But is it wise? How do you know when you have enough in your bank account and investments to sit back and enjoy life? Host, David Stein, discusses the views and math behind one of the more popular early retirement movements called FIRE, which stands for Financially Independent Retire Early. Be sure to listen all the way through!
Do those in the FIRE community have enough to retire?
The FIRE community is the topic of much debate among successful investors and money managers. Financial expert, Suze Orman, for example, hates the FIRE movement. She says that it doesn’t allow for the unexpected in life. How can anyone know if they have saved enough by age 30 to cover their house burning down or an unexpected medical scare?
Mr. Money Mustache (Peter Adeney) disagrees, however. He believes that at the core of FIRE is the desire to live life to the fullest—not to quit working forever. He believes that at the foundation of FIRE is the drive to be able to work the job you would do for free, without having to worry about finances. But can you save enough and invest enough to actually do that? Mr. Money Mustache believes that the FIRE principles stay on the positive side
Deciphering the math for a successful early retirement
Suze Orman says that you would need at least two million dollars to retire early. But do you really need such a large sum? Mr. Money Mustache believes that once you are making enough to pay your living expenses, “while leaving enough of the gains invested each year to keep up with inflation, you’re ready to retire.” In other words, the money you have after spending has to make enough to exceed inflation.
David explains that the formula needs to look like this in order for FIRE to work:
After-tax investment return – spending rate – inflation = greater than zero
If your equation ends up at zero or remains positive, then you will have enough to outpace inflation and keep spending expenses at generally the same rate. If your equation is resulting in negative numbers, however, you will eventually be eating into your principal—shortening the lifespan of your retirement. For examples of this formula in action, listen to the entire episode!
The impact of market losses on early retirement
What if there is a market collapse or at least a downturn in all of the investments you have made to uphold your retirement? David has some helpful spreadsheets that you can work out to determine what your financial situation would be if the stock market fell at various rates after 10, 20, or 30 years. While some may just assume that the market is volatile and that you will eventually make up for any loss, it is more complicated than that. The year a market loss happens in your retirement makes a huge difference.
For example, if the stock market fell 59% at year 10, then the life of your retirement fund could be over in 30 years. If you retired at age 30, then that leaves you at age 60 with no income plan. If the loss were to happen later in the retirement, say year 20, then you have a better chance of surviving the loss with a continued retirement life of 39 more years. There are ways, however, to prepare for such a catastrophe, and it is important to remember that the FIRE movement is more about the holistic approach to retirement—not a never-work-again mindset.
Taking precautions to avoid catastrophe
Most of life involves risk. Investing and planning for retirement are not exempt from some risk-taking. There are steps you can take, however, to better prepare yourself for the unknown road ahead. One step is to spend less. Budgeting out what you are making can help lower the impact of unexpected market turns. David points out that most FIRE retirees still have a source of income. It’s simply that their income comes from a source they love pouring their lives into—something where money really isn’t the largest factor. David encourages the use of modeling out different scenarios using the spreadsheet found in the Insider’s Guide. Play “What if?” and see what might happen in the future if you spend more or less and what would happen if you took a more moderate approach with your investments.
Another step you can take to prepare for a risky future is to diversify your portfolio drivers. Investments don’t need to be your only safeguard. The market is uncertain, and you want to have assets that give you a steady ROI. Private assets, such as a rental property can be incredibly helpful when the market takes a dive with your investments. The important point to note is that no one knows the future. All we can do is prepare the best we can and focus on what truly matters—the quality of life.
- [0:19] Interview opportunity with Suze Orman.
- [1:15] FIRE: Financially Independent Retire Early.
- [2:06] Suze’s response to the FIRE movement.
- [3:36] Controversy over the motives driving FIRE.
- [6:42] Understanding the math of early retirement.
- [12:46] How a market loss would affect your early retirement plan.
- [17:26] Would the FIRE community be better prepared for a market crash?
- [19:03] Modeling out different paths to help prepare against catastrophe.
- [22:28] Utilizing different portfolio drivers.
- [23:53] Viewing early retirement success in terms of probability.
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