“Compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn't, pays it.” - Albert Einstein
What does FIRE stand for? I’m sure most frugal people already know this abbreviation, but for those of you who haven’t heard of it yet: FIRE = (F)inancial (I)ndependence (R)etire (E)arly. The FIRE movement became popular at the beginning of the 2010s, even though the original ideas can be traced back much further. One of the most well-known and most read books is “The Millionaire Next Door”, written by Thomas Stanley and William Danko. Even though they never used the abbreviation FIRE, many of the ideas of the FIRE movement can be linked to this book which was originally published in 1996. As you can see, FIRE in this context is not linked with burning wood.
The basic principles are behind the FIRE movement are simple, and they have been repeated 1000x by numerous blogs in the last years. My own short and condensed version of it is:
- Save more than you spend
- Set up an emergency fund of 3-6 months (of your cost of living)
- Invest your savings in passive world stock market ETFs (e.g. VWRL or VT – no financial advise)
- Repeat points 1 and 3 for the next 20+ years
- Once you reach 25x your annual expenses, you are financially independent
That is the super-simplified version of how to reach financial independence with a high probability. You want to a) save money, b) invest in passive ETFs and c) be financially independent once your net worth reaches 25x your expenses (that’s the famous 4% rule – which is a simplified version of how much money you can withdraw per year from your net worth). Ideally, you save more than 50% of the money you earn every month. The more you save, the more you can invest, the faster you can reach the 25x.
There two main reasons why, in theory, you can retire on 25x your expenses. Reason #1 is called compound interest: instead of paying out the interest you gained, you reinvest it. By doing that over many years, you’ll earn more and more interest. Think of it like a snow-ball: at first, the snow-ball is really tiny. But once it gets more traction and rolls down a hill, while picking up more and more snow, the ball grows bigger and bigger. Reason #2 why you can retire early with 25x your expenses is the stock market itself: over long enough periods of time (15+ or 20+ years), the stock market has been going up. It’s true that “past performance is no guarantee of future results”, but the probabilities are in your favor. On average, the S&P 500 (500 largest US companies according to market capitalization) has returned 10.5% annualized return over the last 64 years (from 1957 until 2021 – see here). That doesn’t mean you’ll get 10.5% every year – it’s the average over a long period of time.
The retire early part of FIRE is not mandatory, but a lot of people are aiming for financial independence to be able to retire earlier.
Reaching financial independence can have a lot of different reasons: some people want to reach it to feel secure, some want to have a peace of mind, for others it might just be nice-to-have. Whatever your motivations are, they are very individual.
Personally I link FI with security and safety. If I don’t have to worry about money anymore, I can enjoy my life to the fullest. Which, in itself, is not how you should approach reaching FI. One of the reasons to start this blog is to get more clear about my own thoughts, feelings and emotions when it comes to financial topics. A lot of people in the FIRE community are brain driven, and usually we are very good at calculating, researching, dissecting and a lot of other things which rely heavily on our brain capacity.
One of the issues I personally see in the FIRE community is the focus on micro-optimization. The (in)famous Homo Economicus is an avatar you will find very often when engaging frequently with FIRE communities. People will discuss back and forth for hours and days about TER (Total Expense Ratio) optimizations for ETFs (Exchange Traded Funds), the cheapest bank account or how to get most out of your cashback points.
Don’t get me wrong – optimizing your expenses is important, especially when you are not able to save money every month. Having an overview about your income and expenses is essential before you can think about investing. Still, some people really drive it to the extreme: Jacob lives on a budget of $7000 in the US. Some of his ideas are really great, and he’s definitely a brilliant mind. I still think that eating canned beans for weeks and driving frugality to the absolute maximum is not the best way to achieve financial independence.
I’m also one of the people who wants to increase his savings rate by as much as I can. To give you an example: as a freelancer, I know exactly how much money I can earn per hour and per day. Which leads my mind to play tricks on me, aka “I could work 2 more hours instead of spending 2 hours doing grocery shopping”. That’s not good for my mental health, and also not good for any romantic relationships. Of course that’s usually only a problem for entrepreneurs or people who are self-employed. From my own experience I can tell you that I was wired the same way when I was still employed: saving vacation days which were paid out after one year, taking on extra duties and on-call services to earn some more money. Again, that’s how I am wired, and it might not at all be the same way for you.
I have a lot of ideas and potential blog posts in my head and in my notes. Starting this blog will help me to clarify my own thoughts. Writing this article took some time and effort, and it was interesting to see how my brain has all those fancy ideas and flashes of inspiration – and how much harder it is to sit down and bring it on paper.
Stay tuned for more topics in the near future.
So long… – FIE
"I'll be back" - T800