Badass vs Dumbass
Master your Financial Kung Fu to be one and not the other.
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Go to Sifu’s Notebook for The Best Methods to Calculate Your FIRE Number
Primer: Who are Sifu & Ronin
Episode 35: Ronin is on FIRE … Again!
Ronin: Sifu, what is this “FIRE Number” I’m hearing about? Isn’t that 911, the number to call if I accidentally set my kitchen on fire from forgetting to turn off the stove when I’m making my five-star ramen recipes?
Sifu: Don’t be a dumbass, Ronin! This magic number has nothing to do with the fire department. The FIRE Number refers to the amount of money you’ll need saved and invested in order to retire early and sustain your lifestyle for the rest of your days, with no need to work again.
Ronin: Oh! That makes sense. But do I need my wizard stick to conjure up this magic number, Dumbledore?
Sifu: Ha! The only magic you’ll need is from your trusty dollar store calculator, that is if your basic arithmetic skills have gone to shit, #1.
Ronin: Doh!
The 4% Rule
Sifu: The 4% Rule is a simple yet powerful method. It states that you can withdraw 4% of your investment portfolio annually without running out of money. To find your FIRE number, you multiply your annual expenses by 25.
Ronin: So, if I spend $40,000 a year on pizza and video games, I need a million bucks? Easy peasy, lemon squeezy! I might get that just by selling my collection of rare action figures!
Sifu: Really, #1? I thought those dust collectors were worth a c-note at best – the whole lot of ‘em.
Ronin: Hey hey. Easy there, Darth Disrespect. I have plenty of time and money invested there. You just watch when this biz goes viral and the value sky-rockets to Mars!
Sifu: Ok, if you say so, Toy Raider. Trust you know more than me about such business. Hope so anyways. Now, the 4% Rule assumes a balanced portfolio and a long-term investment strategy. It is not a get-rich-quick scheme.
Ronin: Ok ok, got it. No buying lottery tickets and calling it a day. Check.
Sifu: Next, we have Lean FIRE and Fat FIRE. Lean FIRE is for those who wish to retire with a minimalist lifestyle, while Fat FIRE is for those who desire a more luxurious retirement.
Ronin: So, Lean FIRE is like living off white rice and biking 15 miles each way to work every day, and Fat FIRE is like retiring in Monaco with a personal Michelin Star chef?
Sifu: Hahaha. Maybe! Lean FIRE requires a smaller FIRE number because your expenses are lower. Fat FIRE, on the other hand, requires a larger FIRE number to support a more extravagant lifestyle.
Ronin: Hmm, I think I’ll aim for Medium FIRE. Enough to afford avocado toast but not so much that I need a butler to serve it.
Sifu: Wise choice, #1. Balance is key in all things, including financial independence.
The Variable Withdrawal Strategy
Sifu: Lastly, we have the Variable Withdrawal Strategy. This method adjusts your withdrawals based on market performance. In good years, you withdraw more; in bad years, you withdraw less. Follow me, Junior Jedi?
Ronin: Roger that, Troop Leader! So, it’s like dieting. Feast during the holidays, starve in January. This variable option sounds like my mortgage – I like that versatility.
Sifu: Indeed, #1. This strategy requires flexibility and a keen understanding of market trends. It can help extend the life of your portfolio during economic downturns.
Ronin: Sounds like a monster rollercoaster at Six Flags. But hey, if it means I can retire early and still afford my comic book addiction, I’m in.
Sifu: Remember, #1, the path to FIRE is not just about the destination but the journey. Each method has its own merits and challenges. Choose the one that aligns with your goals and lifestyle.
Ronin: Yeah, my realistic goal is Medium FIRE and maybe throw in the variable option. Not sure if that aligns to beachfront living though …
Sifu: Ye of little faith. You need to believe in yourself and have the fortitude and confidence to know that you can take it further, to your real goals.
Ronin: Roger that, Space Cowboy! I’m all aboard the positivity train. You’ve lit that FIRE under my ass, boss.
Sifu: Go forth, Ronin, and may the FIRE be with you.
Ronin: Hee-hee.
Sifu’s Notebook
The Best Methods to Calculate Your FIRE Number
When pursuing FIRE (Financial Independence, Retire Early), one of the first things you’ll hear about is the concept of a “FIRE number.” This number represents how much money you need to save and invest to live off your investments for the rest of your life, without needing a traditional job. But calculating your FIRE number isn’t a one-size-fits-all approach. There are different methods depending on your goals, lifestyle, and the assumptions you make about your future expenses, returns, and risks.
1. The 4% Rule
The 4% rule is perhaps the most famous calculation method in the FIRE community. It stems from a study known as the Trinity Study, which analyzed historical stock market data to determine how much you could withdraw from your retirement portfolio without running out of money. The conclusion? If you withdraw 4% of your portfolio each year, you’re likely to sustain your savings for at least 30 years.
For example, if you’ve determined that you need $50,000 a year to live comfortably in retirement, your FIRE number would be calculated by dividing your annual expenses by 0.04 (or multiplying by 25).
$50,000 / 0.04 = $1,250,000
Pros:
- Based on historical data, the 4% rule has worked for many retirees.
- Simple and actionable.
Cons:
- The 4% rule doesn’t account for periods of market downturns or extreme inflation.
- It assumes your spending needs will remain constant, which may not be realistic.
2. Lean FIRE vs. Fat FIRE
The FIRE movement isn’t just about one way to retire. There are subcategories that cater to different lifestyles, two of the most notable being Lean FIRE and Fat FIRE.
- Lean FIRE: This approach focuses on achieving financial independence by living a minimalist lifestyle with low expenses. People who pursue Lean FIRE typically target 20 times their annual expenses rather than the standard 25 (or 5% rule instead of 4%), because they plan to live more frugally. For example, if you expect to live on $30,000 per year in retirement, you would need:
$30,000 / 0.05 = $600,000
- Fat FIRE: On the other end of the spectrum is Fat FIRE, for those who want a more luxurious retirement. Fat FIRE followers aim to have 30 times their annual expenses saved, giving them extra cushion for a higher standard of living (or 3.33% Rule). If you plan to live on $100,000 a year in retirement, your FIRE number might look like:
$100,000 / 0.0333 ~= $3,000,000
Pros:
- Lean FIRE allows you to retire earlier by embracing frugality.
- Fat FIRE gives you more flexibility and comfort in retirement.
Cons:
- Lean FIRE can be risky if unexpected costs arise.
- Fat FIRE requires significantly more savings, meaning it will take longer to reach your goal.
3. The Variable Withdrawal Strategy
Not everyone wants to follow a fixed withdrawal rate. A variable withdrawal strategy allows you to adjust your withdrawals based on market performance. In good years, you can withdraw more, while in bad years, you can tighten your spending. This approach can help ensure that your portfolio lasts longer but requires more active management.
For example, you may aim to withdraw anywhere between 3% and 5% in a given year, adjusting based on your portfolio’s performance and any major life changes. You’d calculate your baseline FIRE number using one of the fixed-rate methods (4%, 3.5%, etc.) and then adjust withdrawals as needed.
Pros:
- Flexibility: You can adapt to market changes, allowing you to spend more in good years.
- Can Stretch Your Portfolio: By reducing withdrawals in market downturns, you can protect your portfolio from being depleted too quickly.
Cons:
- Requires Monitoring: You’ll need to regularly review your portfolio and adjust accordingly.
- Spending Discipline: In bad years, you’ll need to tighten your belt, which might be difficult for some people.
** SPECIAL NOTE **
The FIRE number calculation is based on Total Investable Assets, not total assets. The key idea is that you’re withdrawing 4% (or 3%) annually from a portfolio of assets that are generating returns, such as stocks, bonds, or other investments, which means only your liquid, investable assets count toward this calculation.
Non-investable assets, like the equity in your primary home (if you don’t plan to sell it and use the funds), personal belongings, or cars, don’t usually count toward your FIRE number. Only the assets that can be invested and generate returns, like your retirement accounts, brokerage accounts, and dividend-producing real estate, should be considered.
So, for example, if you need $50,000 a year to live on, and you’re following the 4% rule, you’d need $1.25 million in investable assets ($50,000 ÷ 0.04 = $1.25 million).
