Rob Berger* examines five of the more pernicious myths about the ‘Financial Independence, Retire Early’ principle.
Photo: Alexas Fotos
You’d think that personal finance gurus and pundits would embrace the FIRE (Financial Independence, Retire Early) movement.
The FIRE crowd preaches a debt-free lifestyle, healthy savings rates, smart low-fee investing, and life over money.
What’s not to love?
Yet it seems that some just can’t help hating FIRE.
They claim few can save the amounts of money needed to retire on time, let alone early.
They complain about the return assumptions used in early retirement calculations.
And they proclaim that a FIRE lifestyle is just plain boring.
What’s the point of going without a latte for 25 years in the hopes of one day being financially independent?
Let’s set the record straight by addressing five of the more pernicious myths.
Myth #1: You must save 50 per cent or more to retire early
Those who claim early financial independence requires a savings rate of 50 per cent or more haven’t done the maths.
Of course, the higher the percentage of income you save the sooner you’ll reach financial independence.
Saving one-half of your paycheque, however, isn’t necessary.
Imagine a recent university graduate in their early twenties.
They set as a goal having 25 times their annual expenses in 30 years.
By doing so, they will be financially free in their early fifties.
What percentage of their income must they save to achieve this goal?
The answer depends on two important assumptions.
First, what will their after-inflation return on investments turn be over that time?
Second, does their employer match their retirement contributions?
I use a 6.3 per cent after-inflation return assumption and start with the returns of a portfolio consisting of 70 per cent stock index funds and 30 per cent bond index funds.
Since 1926, such a portfolio has returned 9.3 per cent, according to Vanguard.
Then we subtract inflation, which has averaged just under 3 per cent during the same period.
(Some will argue that the past doesn’t guarantee the future. They are, of course, right. See Myth #4 below.)
With this assumption, our example would need to save 20–25 per cent of their income.
A healthy savings rate, to be sure, but far below the dire claims of 50 per cent or more.
Add in a superannuation match, and they will save another two to three years.
Myth #2: Early retirement means never working again
This canard just won’t die.
It seems that many old people, like me, just won’t let go of our 1970s view of retirement.
Back then we worked until we were 65, and then we stopped working cold turkey.
That’s not retirement today.
Myth #3: FIRE is only for the young
This is arguably the most important myth to debunk.
The concepts, strategies and tactics that enable some to retire in their thirties and forties are desperately needed for those 50 or older with little retirement savings.
The FIRE movement defines financial independence as having 25 times your annual expenses.
For those who retire long before the age of 65, they must rely entirely on the money they have saved.
For those retiring at a more traditional age, most have other sources of income, such as social security.
Myth #4: The next bear market will snuff out the FIRE movement
Many complain about the return assumptions used in FIRE calculations.
In a recent article on Forbes, the author argued one should assume a 2.5 per cent after-inflation return.
But that misses the point.
First, we have no idea how stocks will perform tomorrow, let alone over the next 20 to 30 years.
We can acknowledge that interest rates are at historic lows.
As rates rise, the value of all assets, including stocks and bonds, will fall.
First, let’s remember that the price–earnings ration (P/E) of your portfolio probably doesn’t match that of the S&P 500 (unless 100 per cent of your money is in an S&P 500 index fund).
The trailing P/E of my portfolio is about 16, and the forward P/E is under 15.
Why?
Because many of the asset classes I own, such as foreign companies, small companies, value stocks, and banks, have P/E ratios far below that of the S&P 500.
That’s not to say that my portfolio won’t fall in the next bear market.
It surely will.
And it may fall a lot.
But predictions of portfolio returns based solely on the P/E of the S&P 500 index are of little value.
Second, for those in the accumulation phase of FIRE, a sustained bear market is your best friend.
When stock prices fall, your investment contributions and dividend reinvestments buy more shares.
Finally, the markets will return whatever the markets will return.
We can’t control that.
I’ve found that those who consistently predict gloom and doom are, much like a broken clock, right once or twice each decade.
Myth #5: Early retirement requires saying no to lattes, forever
The latte factor has taken some heat lately.
It turns out millennials don’t like hearing multimillionaire financial gurus telling them to avoid coffee.
Truth be told, I’ve yet to meet an early retiree who achieved FIRE by avoiding lattes.
I have, however, met plenty who have achieved financial independence by avoiding mindless spending.
And that may or may not include lattes.
Here’s a simple strategy.
Decide on your savings rate and work hard to achieve that goal.
Once you achieve your savings rate goal, spend the rest of your money however you want to.
If that means buying lattes, go for it.
* Rob Berger is the Deputy Editor of Forbes Money Advisor. He tweets at @Robert_A_Berger.
This article first appeared at www.forbes.com.
