The Math of Financial Independence & FIRE

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FIRE can be a controversial topic to the masses. Look at any of the comment sections on a featured article it’ll be full of the emotional responses of fear, anger, jealously, rage.  Those of us who write about Financial Independence have a responsibility to be transparent about how we made it because there aren’t shortcuts to financial independence.   The math is four components:  Income, expenses, investment returns, and time.  Everyone’s features about financial independence includes four parts to the story.

Income:  You have to earn money.   Short of a massive inheritance, you’re not going to reach financial independence without earning money.  The more money you can earn, the faster your path to financial independence is.

Your income will likely go up over time.  In many professions your value to an employer grows exponentially from year three to year ten of experience.    People retire out of your field, people get promoted, then you end up on the list to go and take the next level job.   If you’re in sales then you are more experienced in your sales pitch, you know how to identify customers better, and you build an internal reputation for performance.  In the trade skills you complete your work faster with more accuracy.

Income growth may also not be lineal.  You may get a big step in your income with a promotion or changing companies, then suffer through years of mediocre raises before the next jump.   The process of building income can be slow and frustrating – but it usually goes up over time.

Expenses:  The premise of financial independence is you can’t spend all your money.  Its the opposite of the get rich quick real estate courses that make their way from cheap hotel lobby to cheap hotel lobby on weekends, convincing poor souls that the path to freedom is to charge $2,000 on their credit cards for some guru’s course.

You may be able to cut your baseline expenses down to $15,000 – $25,000 in your twenties but those baseline expenses will probably go higher as you get into your thirties.   The personal finance community writes about focusing on expenses because its real money.  The concept of the Big 3 is accurate:  You choose how much money goes to food, housing, and transportation each month.  The latte factor is real too, $5/day for 200+ days a year is real money.  Millionaires are made ten bucks at a time.

Those habits of being cheap frugal stick with you over time.  We’re millionaires now but still will split a grocery order into two so that we can double up and each use a $5 off $25 coupon.  Our “date nights” usually consist of Chick Fil A or Pei Wei ordered through a rewards accruing app.  Call us weird, but we like quick service restaurants because we can get our own drink refills and they don’t carry an obligation to tip.   We drive 11 and 18 year old vehicles because we view them as a tool to get us to and from a destination and not a status symbol.   These things don’t *really* matter at this point in our financial journey, but habits are built early and stick with you for a lifetime.

Once the big three expenses are under control, taking advantage of tax sheltered accounts can cut your current income tax bill by thousands.  Investing those saved funds with low cost providers such as Vanguard and Fidelity drop the fees many people pay on their investments.

These are not either/or arguments:  Paula Pant’s said it best:  Mind The Gap

Investment Returns:   The “normal” path of investments promoted in FI is invest in a a low cost, total stock market index fund.   On the every few year “good year” this will go up by 20%+, most years will have single digit returns, and there will be a flat to negative time periods.  Over a 15 year time period you can get an 8-12% annual return in index funds.

The other option to increase your investment returns is to get more active.  I don’t mean becoming an active stock trader, but putting your funds to work in investments that you also have to show up and work on like rental real estate or your own small business.

There’s occasionally a story about FIRE will pop up that goes something like “Two teachers retire at 30 after only eight years of work!” .  Then you read about all the ways they lived frugally and get further into the story to the part where “They bought real estate in Las Vegas that was selling for $360,000 in 2007 for only $80,000”.    Holy Batman!   The math goes something like they put $20,000 cash in, borrow $60,000, then get an asset that rents for more than enough to cover the mortgage.  Five years later, this house is back to being worth $250,000+.     The couple converts their $20,000 into $250,000 in just five years, a 1250% return on investment over the five year period!

They now own 13+ rentals, which is a serious entrepreneurial business even if outsourced to others to manage.  A more accurate story should read “This savvy couple took entrepreneurial risk and quit their teaching jobs at 30”.

Others invest their time and money into significant online businesses – these online businesses can produce nice cash flow and/or be sold on a multiple of that cash flow.   The businesses that people like Michelle, Bobby, and Robert have built are impressive online businesses.

Time:  We often see these stories of “I retired by 28, I retired by 31” and wonder, how the f@#$ is that possibly. Then we read further into the story and there’s some inheritance or sale of a business enterprises and feel duped.

Once you generate money from the gap between your income and expenses, you rewarded over time by loaning/investing that money into something else. For many of us that looks like low cost index funds inside a retirement account.  Those have been outstanding for nearly a decade and the future may or may not generate similar returns.   One of the huge contributors to our net worth was having at least $100,000 invested for each of the last three 20% return years in the market over the last ten: 2009, 2013, and 2017.   You must endure mediocre years in the market (and a lot of market drops) to pickup these occasional big return years.

Those who have average to below average incomes can achieve financial independence through the use of time and disciplined expense management.  The best example two examples I’ve seen are Jeff (interview #47) and Mr. Earl  investing and time to grow.  There are many more out there and I’ve been fortunate to make rental property loans to some of these low income entrepreneurs.

Simplistic Steph recently wrote about the long time frame of FIRE in a guest post for Your Money Geek.  In that post she did the math at a modest income producing retirement at 47.   Forty seven!  That’s still eighteen years faster than the *normal* working person.   My math was similar ten years ago when I started running the “I had a bad day at work, when can I not do this anymore” numbers.  Income will go up, investments will perform, expenses can be optimized, and time will produce returns.   Stay the course and this will work out.

Retiring early may not be for everyone but financial independence can be. Develop a gap between your income and expenses, invest the difference wisely, then let the power of time run its course.   You’ll be happy you did!

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6 Replies to “The Math of Financial Independence & FIRE”

  1. Time seems to be the hardest part. It is easy enough to do most anything for a little while. But once you get on this FI train and realize that it is really closer to 15+ (50% savings rate) years for most people then it all seems a bit overwhelming. Can I keep expesnese under control for that long is a big question? Holding back lifestyle inflation is a constant battle with our very human desire to want more.

    Of the big three at least the house/car decisions only have to made a couple of times in any given couple of decades. Getting those “right” is huge.

    1. Time is the hardest part – Everyone has to figure out how to enjoy the journey. That has been my biggest personal challenge is avoiding the trap of “I’ll be happy when…”

  2. Can’t agree more with the conclusion about time being THE most difficult component…and this is not only true for FIRE, but many other things as well. Being it regular sports, eating (more) healthy, less unhealthy habits (smoking etc).

    Unfortunately many people don’t have the patience and drive to “invest” in changing or establishing habits, when the target is a bit further in the future 🙁

    Nice blog, thanks for sharing your experiences and thoughts!

  3. Time really is the hardest part. Try doing something that won’t make you regret that you did it and or should we just say be happy with your decisions in life. Thanks for sharing us your life experiences.

    1. I’ve found myself telling people recently that Financial Independence is about small choices made every day over the course of a decade to a decade and a half. Life is about choices and money = time.

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