How To Invest For Fire

By David Krug David Krug is the CEO & President of Bankovia. He's a lifelong expat who has lived in the Philippines, Mexico, Thailand, and Colombia. When he's not reading about cryptocurrencies, he's researching the latest personal finance software. 10 minute read

When you first read about the financial independence, retire early (FIRE) movement, you may question how you should invest differently for FIRE. How can I generate sufficient passive income to pay for my living costs? Fasten your seatbelt and get ready to accelerate your retirement preparation.

Many Needs, Many Risks

The basics of early retirement preparation are similar to those of regular retirement planning, but early retirees may enjoy a long period of leisure, perhaps even half a century or more. 

Investors must sometimes adjust their strategies to account for the varying risks, needs, and opportunities presented by each of these groups. Before we get into actual investments, here’s some background information you should know.

A Brief Overview of FIRE and Safe Withdrawal Rates

The idea of safe withdrawal rates is best summarized by “the 4% rule,” which you should be familiar with.

To properly prepare for retirement, one must have a good idea of how much one will need to save. Further, you’ll need a few other figures in hand to calculate how big of a nest egg you’ll need.

Determine beforehand the annual or monthly amount you’d like to receive from your investments once you’re no longer working. That is, how much money will be required to maintain your current standard of living? Second, you must determine the maximum annual withdrawal amount from your savings.

After retirement, the 4% rule states that there is little to no risk of running out of money within 30 years if you withdraw 4% of your nest fund annually. Having a $1 million nest fund would allow you to withdraw $40k annually to pay your living expenses in retirement.

To determine how much money you need to save for retirement, you can flip the percentages around if you expect to spend $40,000 annually in retirement, multiply that number by 25 to arrive at your desired nest egg of $1 million using a 4% withdrawal rate (100% / 4% = 25).

On the other hand, as naysayers like to point out, early retirees will certainly live more than 30 years in retirement! Fortunately, a 4% withdrawal rate would have kept your nest fund intact for a lot longer than 30 years, and in many cases, it would have kept increasing forever.

If you want greater certainty, though, financial advisor Michael Kitces shows mathematically that a 3.5% withdrawal rate will keep your nest account intact indefinitely, at least in all historical scenarios over the previous century.

And sure, the world’s financial markets could be destroyed in the next decades by a zombie apocalypse or extraterrestrial invasion, throwing all your retirement planning into disarray. However, a prognosis based on a century’s worth of past returns is as good as it gets.

Finally, it’s important to carefully consider how much money you’ll need for every day costs if you retire early. Explore the differences between lean FIRE and fat FIRE; you may find that doing so prompts you to reevaluate some of your present outlays.

To Reduce Sequence Risk, Use The FIREwall

Sequence risk, often known as the risk associated with the timing of your investment returns, is another fundamental concept in retirement planning. It argues that when it comes to protecting your retirement savings, the order in which your investments experience gains is equally as important as their average long-term rates of return.

The sequence of returns risk refers to the potential for a severe market downturn to occur early in retirement, rather than later. Because a larger nest egg can better weather a 30% or greater decline in value, it is important to allow your savings to grow for as long as possible after retirement as the market is bullish.

It’s like getting more bang for your buck: the faster you begin going, the harder it will be to stop. Those rare cases in the past where investors saw their holdings depleted after 30 or 35 years? There was always a stock market decline right about the time the retirees were planning to retire.

However, early retirees have an ace up their sleeve when it comes to fending off sequence risk they can always go back to work if the market crashes in their first few years of retirement. 

This is much simpler for someone in their forties than it would be for someone in their seventies. Yet, in my opinion, the point is frequently moot.

Most people continue to work after quitting their jobs.

Marketers sell the concept of FIRE with the alluring vision of a carefree existence spent lounging in the sun and enjoying a steady supply of margaritas. No one I know, however, has managed to retire before they reached retirement age.

There isn’t a single individual I know who has stayed stagnant after attaining financial freedom at an early age. Unavoidably something pleasurable, something fulfilling, and something that pays at least a little.

Countless people today keep online diaries, launch podcasts, and sell online courses about their experiences in the hopes of inspiring others to follow in their footsteps. 

A number of people keep putting money into high-yield investments and rental properties in the hopes of increasing their income. Some people decide to work for non-profits in order to change the world, and they get the job of their dreams doing it.

Achieving financial independence, and retiring early (FIRE) calls for self-control and determination. Fundamentally lazy people, the kind that would happily lie on a beach all day sipping cocktails with small umbrellas in them, frequently don’t have the zeal to attain FIRE in the first place. 

In practice, this means that being financially secure almost never equates to being able to retire early. Many people I knew in their thirties and forties had finally made it to the point of financial independence. All of them have found new ways to make money, either by founding their own businesses or freelancing, or working for non-profit organizations.

In fact, after retirement, you always have the option of taking on a low-stress job for the sake of variety and supplemental income. While my mother intends to keep up her present side business of educating children, I’d love to work as a wine pourer at a local winery.

There is a subset of FIRE believers that like the idea of “barista FIRE,” or retiring early while working a job you enjoy full or part-time.

Medical Insurance

When I talk to people about FIRE, one of the most frequent concerns they express is the cost of health insurance in the absence of employer-provided coverage.

When an American reaches the age of 65, they are eligible for Medicare, which will replace their workplace health insurance. Those who retire early don’t get that choice.

If your job doesn’t provide health insurance, you’re in luck: You have many choices. It is still something you should plan for in terms of your annual spending once you retire early.

Investment Techniques for FIRE Seekers

Others who have achieved financial independence and are considering retiring early face certain unique benefits and dangers compared to those who wait until they are in their 60s to do so. But does this necessitate a new approach to financial planning? Yes, but only up to a certain point.

Watch out for bonds.

U.S. Treasury bonds, practically risk-free assets, paid nearly 15% interest in 1981. Approximately 1.5% is paid in 2021. This is less than the inflation rate as measured by the CPI. In 2021, buying Treasury bonds is, in fact, a losing proposition for investors.

Even math illiterates can see that if they invest money at a rate of 1.5% per year and remove it at a rate of 4% per year, they will eventually run out of money. Because of this, bonds are not a good investment for those seeking FIRE, at least in the historically low-interest climate of the 21st century. 

Because bonds have traditionally protected seniors’ nest eggs from the volatility of stocks and sequence risk, this is an issue. Fortunately, as we have seen, sequence risk is not something you need to be overly concerned about.

And yet, bonds can still play a part in your asset allocation while you work toward FIRE. When looking for a bond to invest in, keep in mind that the interest you earn on municipal bonds is exempt from federal, state, and local taxes.

The tax benefits, especially for high earners, can increase the effective yield you get, making them a practical investment that can strengthen your portfolio.

Keep to the Fundamentals When Buying Stocks

Sure, you could choose specific stocks or act as if you were a stock picker. And on occasion, when I have a little extra spending money, I do. The vast majority of FIRE aspirants, however, invest in the market as a whole through diversified index funds and low-cost exchange-traded funds (ETFs) rather than trying to choose the next Netflix.

The S&P 500 index has historically returned 10% annually over the long term. If you don’t know what you’re doing with stocks, try a Robo-advisor like SoFi Invest. Alternatively, you can select a few ETFs yourself with even a modest amount of information.

My suggestion is to invest in at least one large-cap U.S. fund, one small-cap U.S. fund, one international developed countries fund, and one emerging markets fund. Your stock portfolio can grow from there, but those four funds are a solid starting point, regardless of how much you end up learning.

If you plan on using a Robo-advisor and you end up becoming wealthy, you should use one until you can afford to transition to a hybrid Robo-human adviser. By forgoing the high costs associated with using a conventional investment advisor, you can retire much sooner.

Add real estate in some form

Trust me when I say that not everyone is a good candidate for direct real estate investment; I know because I am one. You should only think about it if real estate is something you’re truly interested in and if you intend to invest in properties on the side.

Investment in real estate is a good way to diversify your portfolio, but for the ordinary individual, passive strategies are preferable. To invest in real estate without directly doing so, consider crowdfunding platforms like Fundrise, Streitwise, or Groundfloor.

Although publicly traded real estate investment trusts (REITs) are simple to invest in and offer high liquidity, they are not without their limitations. Most importantly, their movement is too correlated with stock indices to serve as a meaningful diversifier.

To diversify my personal portfolio, I’ve substituted bonds with investments in real estate. My real estate holdings have proven to be a much more stable source of income than the stock market. 

Real estate assets aren’t as liquid as stocks and bonds, but I don’t need to sell any of my holdings quickly. Money from my stock portfolio and savings cover any shortfall. There are great tax benefits to making direct property investments.

Reduce Speculation at High Risk

Everyone seems to have a scummy second cousin who made a hundred grand trading Dogecoin or something similar. However, this does not mean that you should rush out and spend your life savings on cryptocurrencies or any other form of speculation.

In addition to traditional assets, I also hold a small amount of cryptocurrency in the form of Bitcoin, Ethereum, and others. I have set aside a small portion of my savings for short-term investments and speculative bets less than 5 percent. The possibility of losing it would be annoying, but it wouldn’t destroy me.

You can invest in equities or risky assets like art or cryptocurrency if you feel the need to prove your intelligence. But don’t risk more than a modest fraction of your total resources. Which is, to be honest, exactly how everyone else should handle these assets.

Using Tax-Sheltered Accounts

Those who are trying to retire early typically have a goal of sending as little money as possible to the government in taxes. Taxes are like money dripping out of the well-oiled engine you’re creating.

Even if you wish to retire at age 40, you can’t access your tax-deferred retirement plan funds until you turn 59 and 12. What should you do to get out of that bind? For starters, you can choose between tax-deferred retirement accounts and regular old taxable brokerage accounts when making investments. 

Aside from the savings, you’ve made for your retirement, your real estate assets can continue to pay you. Before age 59 12, you can rely on your taxable investments, and after that, you can begin withdrawing from your retirement savings.

Health savings accounts (HSAs), education savings accounts (ESAs), and section 529 college savings plans are all options for people seeking tax breaks. If you’re interested in retiring early and making the most of tax-sheltered accounts, you should read this article.

Bottom Line

There are unexpected perks to living the FIRE life. I have chosen to invest the money that would have gone toward things like life insurance or long-term disability coverage. My family can afford to lose one salary because we have a 60% savings rate. 

This also means that in just a few short years of focusing on early retirement, we have amassed a substantial nest egg.

Putting away 40, 50, or 60 percent of your salary has mysterious and beautiful effects. It begins to multiply and grow exponentially. Neither my wife nor I bring in a huge annual salary, but by being frugal we expect to be financially independent in six or seven years.

Dig into the numbers behind early retirement if you’re interested in the meat and potatoes of FIRE. You won’t believe how easy it is to do this, or how quickly you can see results.

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