Followers of the FIRE movement (Financial Independence, Retire Early) don’t want to work until they're 65; they want to retire far earlier. How? By maximising their current income, minimising their expenses, and investing as much as possible and as quickly as possible. The idea is certainly appealing, but it comes with its own set of risks that could undermine your long-term FIRE success.
The FIRE principle: invest early to become financially independent
The FIRE aim is to eliminate all non-essential expenses in order to build up significant savings in the first decades of your working life. Then, when the time comes, you can live off the returns from your investments. FIRE followers estimate that you need a sum equivalent to 25 times your annual income to retire early. This will allow you to withdraw 4% per year without reducing your capital. For example, if you need £40,000 per year to live on, you’ll need to accumulate £1 million – this is your FIRE number, from which point early retirement becomes feasible.
Ultimately, FIRE followers aim for greater control over their lives, with more autonomy and free time to devote to activities they find more fulfilling than salaried work.
But is the goal of retiring early and living off your investments by 40 a realistic one?
Common FIRE mistakes and risks
Here are the main mistakes that can hinder your FIRE success:
#1 – A lifestyle that’s too austere and uncomfortable
Yes, you'll need to be frugal to be able to save and invest over 30% of your income. However, this may not be sustainable in the long term. Are you really prepared to reduce your budgets for leisure, restaurants, holidays? An overly austere lifestyle can lead to frustrations and result in unsustainable efforts over a long period. The FIRE principle shouldn’t involve sacrificing comfort and well-being for 20 years in favour of a future that may not turn out as expected. Saving is important, but it should be done in a reasonable way so it doesn't make life unbearable. If saving becomes hugely uncomfortable, it may be time to reassess your priorities and savings goals, as this could impact your motivation and the overall success of your FIRE project.
#2 – Neglecting your emergency fund
No one can predict the unpredictable, which is why it's essential to have an emergency fund containing cash you can access immediately to cover any unexpected expenses. This fund should cover around six months of your living expenses. Without these readily accessible savings, you may be forced to take on debt; if you suddenly need cash but all your money is tied up in ISAs, property investments, or other long-term investments, for example.
#3 – Failing to account for changing needs
Your needs when you're 25 are not the same as they will be when you're 50. Family circumstances, health, and even comfort levels evolve over time. You can’t simply project your current expenses over 30 years and assume they’ll remain unchanged. It’s likely that your needs will evolve over the decades. Failing to account for this when calculating your FIRE number could jeopardise your retirement.
#4 – Underestimating risks and relying on uncertain calculations
When calculating your FIRE number – the amount you’ll need to retire early and live off passive income – it's likely you'll overlook some important variable. For example, the 4% rule is based on historical data from financial markets with an annual inflation rate of 2%. However, this future projection of financial market returns is partly uncertain. The market operates in cycles, and if we find ourselves in a down cycle in 20 years, your capital and returns will be affected. Projected annualised rates aren’t a guarantee. In a downturn, your capital could devalue by 30% in a single year.
« Inflation is taxation without legislation. »
Additionally, although we know what inflation has been in the past, future inflation rates are entirely unpredictable and this can significantly distort your calculations. Over the past 50 years, inflation has average at 2% annually, but there’s no guarantee this will continue over the next few decades – it could, for example, rise to 3%. So, if you currently need £40,000 per year to live on, with 4% inflation over 20 years, you’ll need £70,000 per year in 20 years to maintain the same standard of living, not £40,000.
When you base your calculations on uncertain variables, you run the risk of your FIRE number not being high enough to provide for your planned future lifestyle.
#5 – Poor investment choices
Of course, FIRE depends on you investing your savings. This is not only to reach your FIRE number but also to generate the passive income needed to maintain your lifestyle once you stop working. Options such as ETFs, property, stocks and bonds are available, but returns are never guaranteed.
We must also mention the risk of changes in the tax regime. There’s no guarantee that tax rules on capital won’t change (to the detriment of investors and aspiring retirees) over the next few decades. This is another uncertainty that could affect your FIRE projections.
Also worth reading: 5 Golden Rules for Achieving Financial Independence
Plan carefully and consider multiple scenarios
Given the uncertainty surrounding historical data-based projections that are used in FIRE calculations, it’s probably wise to also plan for a less-than-favourable, more pessimistic scenario, and to revise the 4% rule, which some see as too optimistic, instead opting for a safer 2.5% withdrawal rate. This equates to needing 40 times your annual expenses as your FIRE number.
If you plan to follow the FIRE method, you’ll need to plan carefully, invest wisely, and be highly disciplined throughout. Keep in mind that these recommendations are designed for people who will be out of the workforce for around 30 years. It’s advisable to consult a financial advisor to tally your goals and strategies.
Finally, if your goal is to get out of a job that isn't working for you, wouldn’t it be more sensible to find a more fulfilling one rather than leave the workforce entirely?
