Many of us fantasize about quitting the workforce while we’re still relatively young, before our children grow into adults and we lose the energy to do the things we love. Then, most of us wake up and get back to work. The amazing thing is, there’s a group of people for whom this is clearly more than a pipe dream.

Do a quick web search and you’ll find a slew of message boards and online classes that offer the basics of “FIRE,” shorthand for “financially independent, retiring early.” Surprisingly, it’s a community that includes a lot of folks without huge salaries—though a healthy paycheck certainly makes the move easier.

So what enables these individuals to make early retirement a reality? It’s not winning the lottery. It’s something much more achievable, though definitely not easy: restraint.

Financial planners typically advise clients to divert 10 percent or more of their salary toward retirement accounts. That advice holds up pretty well if you’re trying to retire in your mid-60s. However, those looking for financial independence at 55, or even 45, need to go after a much more extreme version. At a minimum, the truly FIRE-focused are putting at least half of their income into long-term investments.

As you can imagine, that requires some serious belt-tightening. It starts with keeping those big-ticket items in check. Unless you’re making an elite salary, that means modest homes and second-hand cars. By cutting back on nonessential expenses, you’re freeing up more of your income for investments.

Creating a Savings Target

When you consider how much money you’d need for an extended retirement, you can see why it calls for such an aggressive savings strategy. According to one widely cited maxim, you can safely pull out 4 percent of your investments in your first year of retirement and—adjusting withdrawals for inflation in subsequent years—with reasonable certainty that you won’t outlive your investments.

Some finance experts, however, point out that this axiom was designed for a more or less average retirement length. Those planning a 40-year retirement, they say, should use a more conservative withdrawal rate of 3.5 percent.

What that means is that your nest egg would have to equal 28½ times your annual expenses in order to make it work. Let’s say you live frugally, forgoing a spacious house for a cozy apartment and keeping your discretionary spending to a minimum. After factoring in Social Security benefits, you estimate that you can live off a mere $30,000 from your investments in year one.

You’d still need $855,000 stowed away before you can make that happen. And that’s without factoring in inflation, which will erode your purchasing power over time. Needless to say, building strong savings habits early on in your career and sticking with them are imperative.

Keep in mind that the 4 percent rule—or 3.5 percent rule, in this case—assumes an even mix of stocks and bonds. Too much reliance on fixed-income securities won’t provide the growth your assets will require over several decades. If anything, early retirees need a slightly higher percentage of stocks to fuel their portfolio over the long haul.

Choosing the Right Investments

One of the assumptions that’s sometimes made about FIRE is that you need the investment skills of a Warren Buffett in order to make it happen. Sure, you can afford to quit your job if you just hit on the right stock at just the right time! The fact is that few investors are that good—or that lucky. The real key is choosing the right asset mix and giving as little away to taxes and management fees as possible.

  • Step one is skewing your portfolio toward stocks. Do this especially early in your career, when you have time to wait out a market downturn. There are merits to increasing your bond holdings as you get closer to retirement, but most middle-aged retirees still need more than half their assets in equities in order to provide long-term growth.
  • Another key strategy is limiting the bite Uncle Sam takes of your nest egg. That means maximizing the money you put into tax-advantaged workplace plans and IRAs. Younger workers can put up to $18,000 into their 401(k) each year ($18,500, starting in 2018), and workers who are 50 and over can contribute another $6,000. (You’re also allowed to put an additional $5,500 into a traditional or Roth IRA (those in the 50-and-older age range can contribute an additional $1,000).
  • Avoid tax penalties. The kicker is that you ordinarily won’t be able to tap those assets until you’re 59½, lest you incur a harsh 10 percent penalty on the amount you withdraw. (These penalties apply only to Roth earnings, by the way, not Roth contributions.) So you’ll need to avail yourself of taxable accounts too.

Where to put that money? Index funds are an obvious choice, for a number of reasons. They don’t buy and sell securities as frequently as other funds and therefore don’t produce as much taxable income that weighs down your return. In addition, funds that track an index don’t charge nearly as much in management fees as actively traded ones.

Companies such as Vanguard and Fidelity have a number of funds with expense ratios under 0.06 percent. This means that year in and year out they’re taking a much smaller sliver from your balance. Also, they’re inherently diversified, often holding pieces of hundreds or thousands of different securities. As a result, they spread out risk much more effectively than a small, hand-picked basket of stocks or bond issues.

Is FIRE a practical solution for most workers? Probably not. But if you’re smart and willing to make some financial sacrifices, the reward of a long, relaxing retirement awaits.


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