This post was inspired by a lively discussion on Reddit. What I have to share on the topic may seem controversial or critical; however, my reason for sharing this is to help you be successful in your goals.
The FIRE Movement
An interesting development over the last several years has been the Financial Independence/Retire Early (FIRE) movement. Financial independence is defined as having sufficient passive income and/or sufficient investments to cover your Living expenses. The turning point is when you have saved enough or reduced your expenses enough to achieve “financial independence”. Once you have reached financial independence, you are now free to live the good life, or at least that is how the story goes.
Since financial independence is a formula, those seeking FIRE often focus on both sides of the equation, being the reduction of living expenses and increasing passive income and investments. Many on the FIRE path will go to such heroic efforts to minimize expenses that they can achieve the definition of FIRE with comparably very little saved, sometimes referred to as Lean Fire.
Lean FIRE is steeped in anti-consumerism, simple living, and even homesteading. Despite the proliferation and popularity of blogs, books and web forums, the pursuit of FIRE is not new. The acronym is a recent development; however, the concept of reaching financial independence and retiring early was not born of the internet nor of recent time. The concept easily dates to the 1960’s, and I bet that one could easily make an argument that the U.S.A. was founded by the godfathers of geo-arbitrage. Fortunately, people pursuing FIRE or lean FIRE have the benefit of learning from those that came before them.
Are You Pursuing FIRE or Lean FIRE?
Some people may argue the difference is just “semantics”. I believe words matter. A yacht and a kayak are both vessels; however, if I told you I took my vessel out on the open water this weekend, you could be forgiven for thinking I owned something much grander than a kayak. Similarly, if someone told you they reached “Financial Independence”, I doubt the image that comes to mind is of one living in a yurt in their neighbour’s backyard. Being frugal and living simply is impressive and admirable. As a community, though, we need to ensure we are all on the same page.
As such, I propose we modify the definition of FIRE. In my opinion, financial independence should equal having sufficient passive income and investments to replace your wages, or the median income (like cost of living) for the community you are living in. Financial independence should entail some form of contingency planning and/or redundancy. As well, I would argue that failing to plan for variables is not a plan at all: if one variable threatens your independence, then as a definition, you are not as financially independent as you believed you were.
Lean FIRE would mean that you have chosen a FIRE path that focuses on simple living and frugality to achieve your goals. It also means you do not have sufficient resources for FIRE.
Of course, if you are leaving your job to turn a side hustle into your main gig, and you need that active income to maintain your standard of living, I would consider that as self-employment on the path to FIRE.
Why Does any of this Matter?
Good planning entails considering what could reasonably go wrong, and planning ahead for contingencies. Good planning needs to work in good times and in bad. Both forms of FIRE have some risks. The leaner the FIRE, the more risks you may need to plan for.
Let’s talk about what can go wrong.
Living expenses will go up over time, and inflation is hard to measure or even forecast. This is in part because inflation affects households differently. If you ask a cattle farmer, a truck driver and a technology consultant how much expenses go up annually, you are likely to get three very different answers. The farmer and the truck driver are much more sensitive to changes in energy and commodity prices than the tech consultant. In fact, the tech consultant may argue that expenses decline!
People express their belief that their stock market linked portfolio will keep up with inflation. They make the assumption that the stock market returns will beat the “average” rate of inflation. The question is, will you experience average rates of inflation? Will people, such as retirees that need to allocate a high proportion of the passive income to living expenses, tend to be more sensitive to inflation in energy and commodities?
TIP: Make sure your inflation protection strategy is correlated to the inflation you are likely to experience, not just a general cost of living inflation.
Tax policies change and evolve over time. The only thing we know for certain is that we don’t know anything for certain. Luckily, the various income taxes are easy enough to plan for. The change is in the property taxes and indirect taxes. In many areas of the country, property taxes have steadily increased at rates greater than the rate of inflation. An extremely lean FIRE plan may not be able to keep up with property tax inflation.
We must worry about indirect taxes, are you prepared if the town you live in doubles or triples the water bill? If you reside in the country, and rely on a well or septic system, do you plan for the potential cost of conversion to public water and sewer if the township mandates that change? A mandated change like that today could cost $15k. What would it cost in ten or fifteen years?
TIP: Consider setting aside extra money for rainy day emergencies before leaving the workforce.
The Great Recession taught us several lessons about portfolio design and volatility in income-producing portfolios. We have also learned that correlations change. In 2008, multiple asset categories experienced losses. One thing I often hear people on the path to FIRE say is if their portfolio loses value they will just “go back to work”. The financial crisis taught us that weakness in the stock markets tend to correlate highly with weakness in the job market. If that wasn’t bad enough, the same finance downturn that damaged your portfolio could also trigger a layoff where your tenant works, and now he is unable to pay rent.
Health care and health insurance are some of the biggest challenges to those aspiring to FIRE and Lean FIRE. The Affordable Care Act has created some opportunities for people to purchase cost-effect insurance if the same people have structured their taxable income in the ideal manner. The issue remains that, over the course of 15 to 25 years, we do not know what health insurance programs will look like. Historically, health care costs increase at a greater than average rate versus the rate of inflation. It would be prudent to plan accordingly.
I have heard people in the lean FIRE community indicated that they will engage in medical tourism. As appealing as traveling to Belize for your health care may sound, unexpected health issues don’t often give us much warning. Quite often, health issues do not make time for travel either.
Many individuals on the path to FIRE include some form of rental properties for income in their FIRE portfolio. Real estate offers some compelling advantages: namely, you can purchase a rental property with “little to no money down”. I cannot begin to count the number of satellite radio commercials or infomercials that pitch the rental property passive income dream. Rental properties are not without risk; landlords can and often get sued. Recently, a tenant was awarded $300k over a bedbug infestation. Even with adequate insurance, a lawsuit can be costly. Neither property insurance nor liability insurance covers property owners if the town or city levies fines or requires improvements on the property.
TIP: Should your path to FIRE include rental properties, consult your lawyer and your accountant about what planning may be necessary to protect your assets. Asset protection is not a substitute for quality liability insurance.
Many marriages end in divorce. Out of the number of people who get divorced each year, I’m willing to bet there’s a handful of couples that would have insisted prior to their marriage going south that they would never possibly get divorced. Your spouse may be onboard with your lean FIRE dreams now. Ask each other what happens if opinions change. Many couples that embarked on homesteading or self-sufficiency found out that overly simple living wasn’t as romantic and charming as it sounded. Alternatively, if you are lean FIRE, and your spouse is not able to visit the children or grandchildren as often as wanted because it’s not “in the budget”, will that spouse remain onboard? Potentially, too lean of a FIRE could lead to anxiety and resentment. Please do not risk your marriage by retiring too early.
TIP: make sure you have adequate pre-nuptial and/or post nuptial agreements.
Failed FIRE: What is the cost?
I have attempted to point out some of the risks to people on social media. Their responses are usually a glib answer such as “I will just go back to work.” The problem with that answer is, if your plan fails, it could be too late. It’s doubtful you’re going to abandon your FIRE dream due to a bad day in the stock market, or even two. You many not realize your plan is not working until it is too late. You may be several years, or even a decade into your plan when you realize you have a problem. In case of a medical emergency, you may be physically unable to work. Re-entering the work force may be harder than you anticipated.
Let’s be clear: should you leave your profession prematurely and find out a handful of years down the road that your planning did not work out, you’re unlikely to get much sympathy. It’s highly unlikely your previous employers will hire you back. Even if they do, it may not be at the paygrades you were previously at. A ten-year hiatus in your resume may cause difficulty in seeking employment, if for no other reason, ten years is a long time in certain industries, and skills perish over time.
Your Definition of FIRE
You should be prepared for the above situations, although I am hopeful these things do not happen to you. When you are prepared and have a plan in place to deal with the curve balls that life tosses at you, then that is the moment when you are truly financially “independent.” There is nothing wrong with trying to retire early or live simply. Good planning means you can enjoy your retirement with peace of mind and security.
The key is to choose a path to FIRE that is sustainable and works for you, your family, and your goals.