Retire Early: Learn the FIRE Method

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A new movement is starting to gain traction: FIRE– Financial Independence, Retire Early. Of course, Millennials are leading the charge. They are asking an important question: why should I have to work decades until I’m 62 years old, the average retirement age? Yes, 62 is the minimum age that you can finally collect your Social Security benefits, but does it make sense to wait that long? FIRE followers recognize that in America we are slaves to consumerism, many of us spending far out of our means using credit. It’s a simple equation. Simplify your spending, simplify your life. Save more = Retire early. Let’s go through the steps for you to implement the FIRE method, so that you can see if you would like to join the path of retiring early. Or, follow these steps in general to help you plan your retirement.

1. Choose Your Retirement Goal

To understand how much money you need to make and save, you need to work backwards. Ask yourself: How much money do I need for retirement? There are tons of online calculators that will spit out a number for you if you just Google search “retirement calculators”. However, I like doing this the old school way. 

Let’s assume that your investment every year will grow by 5% after that pesky thing called inflation (inflation is when the prices of things are going up but your money is worth less). When you retire, the common practice is that you should only take out 4% of money from your investment account. That 4% rate is there to protect you.

5% – 4% = 1%.

This equation means that your retirement account will continue to grow by 1% each year, so that you never actually touch the money that you contributed to the retirement account. 

So how much do you want to live off of each year. Let’s say that you want to live off of $40,000 a year in retirement. That means that you would need $1,000,000 in your retirement account at the time that you retire. 

$1,000,000 * 4% = $40,000

Essentially, all that you need to know to define your retirement goal is how much you are willing to live on each year during retirement. If you want to take a cruise around the world or know that your children are going to be begging you for a downpayment on their house, healthily increase your annual “retirement salary”. If you’re going to downsize and sell your house to see the beautiful USA on an RV, cautiously decrease your annual “retirement salary”. Be honest with yourself. You should know your budget, know your mind, and know how you deal with money. 

 

2. Choose When You Want to Retire

Only you know when you want to retire. The FIRE method typically has people who want to retire by 50 years old. But choose the age when you would like to retire. 

Retirement Age – Current Age = Years to Save

Say that you’re currently 30 and would like to retire by 50. You have 20 years to save, save, save.

 

3. Pick Your Savings Rate

Now that we know our retirement goal and the when you’re going to retire, let’s continue to work backwards and choose our savings rate. 

First, go to your app, excel sheet, or journal of where your budget is located. If you do not have your budget written down somewhere, now is the time to do it. Then, look at your income and expenses. 

According the Value Penguin, the average household income in 2013 was $63,784. Value Penguin has the average household budget broken down into various categories. In the table we see that only 8% or $5,252 of income is going to debt payments or savings. That’s not even just savings! If you know anything about the 50/20/30 rule, where 50% of your after-tax income should go to your necessities (e.g. housing, transportation, utilities), 20% to savings, and 30% to wants (e.g. entertainment, shopping, eating out). 20% is so far off from the average of 8%. 

But all of these numbers are merely benchmarks. What savings rate do you need to retire?

Let’s go back to our example. 

Let’s say you make $65,000 a year from the age of 30 to 50 to be conservative. Your after-tax income in a place like Denver would be $49,419 if you’re a single filer. 

Using BankRate’s Investment Calculator, you see we need to save $22,506 every year for 20 years to get $1,000,000 before taxes and inflation in our retirement account by 50 years old, which would leave us $26,913 to live on a year or $2,242.75 a month. This savings rate is 46%, which is way more than saving 20% of your income. 

Now that we’ve gone through the process of finding your retirement goal, time to retirement, and savings rate, you can see how many variables affect how much you could possibly live off of in retirement. Whether you want to use the FIRE method and save rapidly for an earlier retirement or want to retire at 62, use this process to plan for your retirement. Next week I will write about what type of investments you should make so that you actually meet your retirement goal.

What is your retirement goal? Comment below.

This post contains content this is for informational purposes only, and should not be considered legal or financial advice. You should consult with a legal professional and financial professional to determine what may be best for your individual needs. Please read my Disclaimer for more information.

 

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