Those following the FIRE movement (Financial Independence, Retire Early) don’t want to work until 65. They prefer to retire much 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 idea 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 expenses to retire early. This allows you to withdraw 4% per year without reducing your capital. For example, if you need £40,000 per year to live, 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 realistic?
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
Frugality is necessary 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 to avoid making the process painful. If saving feels like suffering, 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 an emergency fund with immediately available cash is essential to cover unexpected expenses. This fund should cover around six months of living expenses. Without this readily accessible savings, you may need to take on debt if your money is tied up in ISAs, property investments, or other long-term investments when you face a sudden need for cash.
#3 – Failing to account for changing needs
Your needs at 25 are not the same as they will be at 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 change over the decades. Failing to account for this when calculating your FIRE number could jeopardise the project.
#4 – Underestimating risks and relying on uncertain calculations
In calculating your FIRE number – the amount you’ll need to retire early and live off passive income – many variables are often overlooked. 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 lose 30% of its value in a single year.
« Inflation is taxation without legislation. »
Additionally, inflation, while known historically, is entirely unpredictable for the future and can significantly distort your calculations. Over the past 50 years, we’ve had an average of 2% annual inflation, but there’s no guarantee it will remain the same for the next few decades – it could, for example, rise to 3%. So, if you currently need £40,000 per year to live, 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.
#5 – Poor investment choices
Finally, it’s essential to invest 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, stock picking, and bonds are available, but returns are never guaranteed.
We must also mention the risk of taxation changes. 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
Careful planning and considering multiple scenarios
Given the uncertainties surrounding projections based on historical data used in FIRE calculations, it’s probably wise to consider an unfavourable, pessimistic scenario, and to revise the 4% rule, which is too optimistic, opting instead 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 remain highly disciplined. 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 adjust your goals and strategies.
Finally, if the goal is to escape an unsatisfactory job, wouldn’t it be more sensible to find a more fulfilling job rather than leave the workforce entirely?
