Financial independence and early retirement for the complete beginner
After blogging about financial independence and early retirement for as long as I have (November 2014), I start to lose sight of the basics. You know, the things that millions of people actually care about. They don't care about the nitty-gritty, at least yet. They want to know what they need to know. The rest can come later.
And, this article serves to address just that type of want.
Today, let's get back to basics and take a look at what this whole FI and RE thing actually means - especially to those who may not yet be in the position to call themselves intentionally unemployed.
The complete beginner's question and answers guide to Financial Independence and Early Retirement
First - here's a secret: The FI/RE movement is about maximizing happiness, not just quitting your job
Many of us bloggers get caught up in the desire to quit our jobs. Of course, there is nothing inherently wrong with that. Quitting jobs that we don't enjoy is part of maximizing happiness.
But as the FI/RE movement continues to get more and more play in national media, our stories begin to all sound the same, and it hurts every damn one of us. We aren't all just super highly paid millionaires living on easy street.
Many of us who blog do fit this bill, but we are also such a small representation of the larger community. Our stories begin to shape the perception of FI/RE when the reality is early retirement isn't about quitting your job at all. Or making a ton of cash.
Or having absolutely everything figured out.
This FI/RE movement is about happiness. Nothing more, nothing less.
The gritty details of incomes, cash flow, and net worths aren't what is most important in this conversation. Those details matter, but they also don't tell the whole story of why.
This is the story of what makes us smile and it's going to be different for each and every one of us. We travel. Others hate to travel. Some might want to live in a high cost-of-living area while others prefer something different. #Vanlife. House-sitting. Minimalism. FatFire. LeanFire.
Guys and gals, it doesn't f'ing matter.
Our level of happiness stems from knowing the "why". Answering the why question is THE single most important factor in financial independence and early retirement. Without knowing the why, you're in for a world of hurt.
What's the difference between financial independence and early retirement?
These two concepts are mutually exclusive, and it's important to note that while there is incredible wisdom in achieving FI, the ER part is 100% optional.
Financial Independence means that you have enough money to sustain your lifestyle without holding down a job or a significant means of cash flow. There's nothing to say that you can't continue to work a full-time job even after achieving financial independence.
Early Retirement means you've quit the rat race. You're no longer working a full-time job even though you might be earning money in one of your passion pursuits (blogging, woodworking, etc). Early retirement implies that you're financially independent.
Sometimes, you'll hear these two concepts referred to as FIRE, or FI/RE. Though, other derivatives exist, like FIOR and FFLC.
If you're looking for a bunch of completely meaningless buzzwords and acronyms, I got ya covered.
Who are the people who are retiring early?
Anyone and everyone. Men and women.
From all walks of life, people are achieving financial independence and quitting the rat race early. Yes, even those who aren't working high-paying careers in technology. Though there are many tech professionals who call it quits early, they aren't the only ones.
Jason Fieber at MrFreeAt33 retired early after working as a service manager at a car dealership.
Tanja Hester and her husband at Our Next Life retired early after working as business / political consultants.
John from ESI Money retired after many years in business and admittedly doesn't know anything about IT or computers.
Mike and his wife from Uncommon Dream reached financial independence in their 30s on two 5-digit incomes.
Who else? How about Jillian from Montana Money Adventures (non-profit work), Fritz from Retirement Manifesto, Amy from Life Zemplified, Grant from Millennial Money, Chad from Coach Carson (who admits to NO computer skills), Liz from Ms. Money Matters, Mr. and Mrs. Pie from Plan Invest Escape, and Chris from Can I Retire Yet.
And, there's so many more. I believe that the personal finance blogosphere seems heavily infiltrated by technology folks because, at least in part, they are more comfortable with building a blog. They are more likely to know how to find web hosting and start their new blogging career sitting in front of the computer - something they are already very familiar with.
That, and there's no denying that technology careers pay good money, and the more money you make, the easier it can be to achieve financial independence and early retirement.
How do I put myself into the position to retire early?
I like to think of retirement as a number, not an age.
The government-defined age of retirement in your early 60s is nonsense and it doesn't need to represent your definition of retirement.
Instead of looking at retirement through the lens of age, think of it instead as something as simple as a dollar value. That's it - a simple dollar value. The dollar value that we're talking about represents the amount of money that you need to live the rest of your life without having to work again.
Fundamentally, it really is that simple.
Don't let anyone try to sell you on the idea that it's more complicated than that (and that their book or seminar will magically make sense of everything). That duck ain't quackin'.
To put yourself into the position to retire early, your number (otherwise known more collectively as your "net worth") needs to be high enough to fully support your lifestyle. And by that, I mean your yearly expenses.
If you want to spend $50,000 a year in retirement, then your net worth (and your liquid cash) needs to support spending about $500,000 every 10 years - with the understanding that your investments (stock market, real estate, etc) will continue to grow over that time. Historically, it works.
Thus, you aren't losing $500,000 in 10 years. Instead, you're spending it. Yes, there is a difference, and that difference is the magic sauce behind calling it quits early.
Moral of the story: The less it takes to fund your post-retirement lifestyle, the sooner you'll be able to retire.
What does FI/RE look like?
This is similar to asking the question "What does holding a full-time job look like?". There are so many different ways to work a full-time job. And likewise, everybody's idea of living a financially-free lifestyle will look very, very different.
For my wife and I, it's about full-time travel in our Airstream. But for someone else, it might include living in a traditional house and going about life as they always had - minus the job, of course!
Jason Fieber (mentioned above) lives in Thailand. Others, like Jim from Route To Retire, plans to move to Panama. Shacking up in extremely low-cost countries can do amazing things to your bottom line and the expatriate life continues to grow in popularity.
For most of us, we aren't living like rockstars after calling it quits from full-time work. Many of us lived those baller years in a previous life, though. Me included. I made a ton of mistakes, but early retirees learn from those mistakes and move on with their lives with a keen understanding of what actually makes them happy.
FI/RE looks like our definition of happiness - whatever that may be.
Is it all about making more money?
Sure, it can be. But, it doesn't need to be.
Financial independence is generated in a few different ways:
- Increasing income
- Reducing expenses
We saved 70% of our combined salaries and drastically reduced what we spent money on. We both earned decent salaries in information technology and saving a lot of additional cash was pretty easy for us once we mutually decided that we both wanted to quit our jobs to travel. That decision was completely life-changing for us.
Before every expense, we talked about what value it brought to our lives. Each time, we asked ourselves if spending money on such and such thing was worth potentially working longer in order to fund it.
In almost every circumstance, the answer was 'No'.
Increasing income is another way to achieve financial independence. But, how? Consider these three primary options:
- Find another job - throughout my career, I switched jobs every four or five years, and each time that I accepted a position, it came with a nice healthy raise. Switching jobs enabled me to continue an upward trend in salary, helping to put us in a position to make our post-retirement dreams come true.
- Start a side hustle - side hustles are things we do on the side that generate income. For example, blogging is a common one (though it doesn't always make money!). Woodworking. Building houses. An in-depth discussion of side hustles is beyond the scope of this article, but they can easily provide an additional source of income to help fund retirement.
- Invest in real estate - buying and flipping homes is a popular money-making endeavor, but it definitely takes some practice. And, we generally need to come to the table with at least a little cash upfront. Renting out multi-family units (like small apartment buildings) is another way to generate cash flow. Of course, this requires money to be spent up front.
There are so many different ways to increase your income. Many believe that's easier (and more fun). Others, like my wife and me, prefer the reduction in expenses and living a more sensible lifestyle.
Pick the one that works better for you and stick to it.
What's the 4% rule all about?
In 1998, four professors at Trinity University conducted a study that, unbeknownst to them, would serve as one of the premiere guiding forces behind the early retirement movement.
The goal of the study was to determine a "safe withdrawal rate" from retirement portfolios that, through the ebbs and flows of the market, stood the best chances of never running out. In other words, how much money can be spent based on our net worth while minimizing our chances of completely running out of cash.
This is often called the "Trinity Study" or the "4% Rule".
The study found that, even though economic downturns like the Great Depression and subsequent recessions, the typical person can spend about 4% of their net worth every year and stand a reasonable chance of success in retirement. In this case, "success" means not running out of cash.
This study assumes that your money is invested, not simply shoved under your mattress. And, it needs to last 30 years.
Criticisms of the 4% rule include the one-size-fits-all approach of the study. In other words, it won't work for everyone. And, it's true.
A withdrawal rate of 4% doesn't have a 100% chance of success.
I like to call the study a guideline, not a rule.
Meaning, we choose a number that we believe to be a reasonably safe withdrawal rate and start into our retirements by withdrawing from our investments that amount of money.
But, as well-known personal finance and early retiree blogger Mr. Money Mustache writes (and one who happens to believe in the 4% principle), there are no guarantees in life and we should always adjust our expenditures based on economic conditions.
From MMM: So there’s no need to debate. 4% is a perfectly good answer, which means 25 times your annual expenses is a perfectly good goal to save for. Along the way, you might find your annual expenses melting away, which makes things ever-more-attainable
Another popular early retiree who believes in the 4% rule, Go Curry Cracker, offers the same advice, arguing “But to be reasonable, remember the 4% Rule is a Rule of Thumb based on experience, not a Law of Nature. It is the base of a plan”.
This is even more true with early retirees, as they’ve managed their money throughout their working years and have a good enough grasp on personal finance to manage their money and make it last by living cheaply and, most importantly, adjusting to market conditions – especially after the dependable paycheck stops rolling in from full-time work.
Is early retirement risky?
In short, yes. Early retirement is a risk.
But, it's also a calculated risk. Meaning, early retirees have done the math and are confident enough that they'll never run out of money.
Many, like my wife and me, are so confident that we called it quits with only about a million bucks - a number that many so-called "experts" believe won't be nearly enough. But, my wife and I don't live our lives based on what "experts" believe.
We're flexible people. If we feel like we might need to find part-time work to help us through a recession (or depression), we'll do whatever we have to do to make it work.
But, it's still a risk. Anything can happen.
There are no two ways about it: if you are more risk averse, then early retirement might not be in your future. Or at the very least, you'll want three, four or maybe five times what you think you'll need before actually pulling the plug.
There is no right or wrong answer. Ultimately, whatever helps us to sleep at night is the right way to go through life.
I'm confused - what's all this about long-term investments, short-term cash, emergency funds, and savings accounts?
There are a slew of different methods and mechanisms to put your money to work. While a detailed look at the ins and outs of every method is well beyond the scope of this article, it is prudent to talk about this.
The key to financial independence and early retirement lies in the accessibility of your money. The more accessible your money is, the easier it's going to be to live off of that money. And, the earlier that one retires, the more important this issue becomes.
Here are the four primary methods to hold money:
Long-term investments like your 401k, 403B and Roth IRA are designed to provide spendable cash in your traditional retirement years (think 60s and older). Although there are backdoor ways to get at this money before 59 and 1/2 (as of the time of this writing), long-term retirement accounts like these are NOT typically what early retirees live off of when young - even if they've quit their full-time jobs and don't earn an income.
The intent is for long-term investments to grow over time in the market and to be "locked in" until you're older.
Short-term investments include taxable brokerage accounts, index and mutual funds, individual company stocks and real estate. Investors can much more easily access this cash throughout life, and many early retirees fund at least a portion of their lifestyle using short-term investments.
My wife and I have a taxable Vanguard brokerage account that we use to shore up any deficits in our checking account.
Savings and money market accounts are a great way to separate out money that's earmarked for a purpose - like an emergency fund, for example. Money in these accounts can grow, but much more slowly than in long-term and short-term investments.
Early retirees generally don't fund their day-to-day expenses using money in a savings account (though they could). Savings accounts weren't designed for this purpose. However, this money is easy to access.
Checking accounts are designed to fund daily expenses and pay off credit cards (before accruing interest!). Money in checking accounts doesn't grow, so we minimize the cash that we keep in these accounts. However, this money is extremely easy to access and provides a very straight-forward way to fund our day-to-day activities.
Early retirees definitely use checking accounts. It is typical for early retirees to sell stock or dividends from their short-term investment accounts and deposit that money into a checking account before spending it.
What about health insurance?
This is one of the most common questions that I'm asked as someone who called it quits from full-time work. And, it's a reasonable question! After all, health costs are very often our highest cost after we rid ourselves of debts.
We use Liberty Health share.
Technically, it's not health "insurance". It's more of a group of relatively healthy people who collectively share the costs of healthcare. We are treated as cash-paying patients at hospitals and doctors offices, which sometimes helps to encourage hospitals to slash their prices even below what insurance companies can negotiate.
As full-time travelers, we don't have a primary care physician. We can't. We can't depend on being in one place every time we need medical attention. For digital nomads like us, the health share is our only affordable option, and it's an option that more and more digital nomads are pursuing.
If you are an RVer, here's a good source of information on coverage.
Aren't all health shares based on religious principles? Yes, most are. But, some are more stringent than others. Liberty, for example, is one of the least stringent health share providers on the market.
What other questions do you have as a beginner to financial independence and early retirement that I missed?