How long do you need to work to retire? Fifty years? Forty?
According to Jacob Lund Fisker, you may be able to retire in just five years.
One of the early popularizers of the modern FIRE movement (financial independence, retire early), Fisker published his book “Early Retirement Extreme: A Philosophical and Practical Guide to Financial Independence” (sometimes shortened to ERE) back in 2007. Some adherents have since used its practices to retire young. The concept has plenty going for it, but like all things extreme, it remains a fringe movement.
Before you start preparing for your early retirement, make sure you understand not just the math, but the more nuanced personal finance notions behind financial independence.
Early Retirement Extreme: The Concept
Although Fisker has since said he regrets using the term “early retirement extreme,” his ideas do strike most people as extreme.
His underlying premise: the average person in the developed world can retire in just a few years if they follow a few simple concepts: slash your spending to supercharge your savings rate, and invest that savings to create passive income.
Spend Less, Save More
Plenty of people think of themselves as “frugal.” But Fisker operates on a different level, living on only $7,000 per year.
He never eats out at restaurants, lives in a very inexpensive home, and splits the expenses evenly with his wife. Additionally, he grows some of his own food using a home garden, makes some of his own furniture, and scores free stuff from resources like Freecycle.
Fisker recommends other ways of cutting down costs, like borrowing Kindle books and audiobooks from a digital library rather than buying them on Amazon, and learning how to take advantage of “loss leaders” at grocery stores.
None of these concepts are earth-shattering; many college students apply a number of these methods to save money. Fisker just suggests extending that hyper-frugality a little longer.
By living cheaply and saving as much money as possible, you can retire much faster. It comes at the problem from both angles: you build wealth faster, and you require less replacement income to live on in retirement.
Invest for Passive Income
Saving money is all well and good, but the real magic happens when you invest that money to compound or generate passive income for you. With enough passive income from your investments, you no longer need to work full-time in order to pay your bills. It’s called financial independence (or financial freedom): you can cover your living expenses without a day job.
For example, I’m a real estate investor. I live on a fraction of my income, and save and invest the rest. Some of that savings goes into buying rental properties, which generate ongoing rental income for me each month. With enough rental income, I no longer need a day job — I can go travel the world with my family. (Which I do, spending 10 months of the year overseas.)
The Math Behind Retiring Early
The concept is simple enough: build passive income streams from your savings, replace your day job. But how does the math look? Can you really retire in five or 10 years?
The short answer: you can, but it takes a (very) high savings rate. And a higher income certainly helps.
But before breaking down the math of early retirement, you need a few foundational concepts.
From Nest Egg to Passive Income
Most people start their retirement planning by asking the wrong question. They ask, “How much money do I need to retire?” when they should ask, “How much passive income do I need in retirement?” From there, you can estimate how much money you need to retire. But it starts with your target retirement income.
Retirees typically withdraw a certain percentage of their nest egg each year to cover their living expenses. They base that percentage on what’s called a safe withdrawal rate, which varies based on how long they need their nest egg to last. If you retire at 75 and only expect to live another 10 to 15 years, you can pull out money much faster than if you retire at 40 and hope to live another 50 years.
Many retirees follow the “4% rule,” taking a withdrawal rate of 4% of their nest egg each year. Historical returns on bonds and the stock market suggest that a withdrawal rate of 4% should leave your nest egg intact for at least 30 years.
Knowing your future withdrawal rate enables you to calculate how much you need to save for retirement. At a 4% withdrawal rate, you need 25 times your target annual retirement income as a nest egg (4% x 25 = 100%). So, if you wanted $40,000 per year in retirement income, you’d need $1,000,000 as a target nest egg.
Wrinkles and a Wrinkly Example
First of all, note that we can ignore Social Security income, since we’re talking about retiring young.
Now come two wrinkles. First, early retirees need their money to last longer than 30 years. Financial planner Michael Kitces demonstrates that a 3.5% withdrawal rate should theoretically leave your nest egg intact forever. That means early retirees can use a 3.5% withdrawal rate for their planning, regardless of how young they plan to retire. Which, in turn, means you can multiply your target retirement income by around 28.6 to reach a target nest egg. For a $40,000 retirement income, that comes to a nest egg of $1,142,857.
The second wrinkle is that withdrawal rates assume you invested all your nest egg in paper assets (stocks and bonds). If you invest in assets like rental properties, they generate ongoing passive income without having to sell off any assets. Plus you can leverage other people’s money to buy them.
Which means you can cheat on the withdrawal rate — if you develop the skills necessary to invest in real estate.
Continuing the example, say you want $40,000 per year in retirement income and aim for half to come from paper assets and the other half from rental properties. To collect $20,000 in income from paper assets at a 3.5% withdrawal rate, you need $571,429 in stocks and bonds.
Rentals are harder to calculate and require some assumptions. Say you’re buying properties at an 8% cap rate, which means an 8% annual yield if you buy in cash. For a $100,000 property, that means you’d pocket $8,000 per year after non-mortgage expenses. But you instead finance 80% of the purchase price, borrowing $80,000 at, let’s say, 5% interest for 30 years.
That drops your investment from $100,000 to $20,000, and drops your annual net income to $2,846 after your mortgage payments. That means you’d need to buy around seven of those properties to generate $20,000 in annual net rental income. In this example, seven of these properties come to $140,000 in down payments.
Your total combined savings target for both your paper assets and your down payments then comes to $711,429 ($571,429 + $140,000), in order to generate $40,000 in annual passive income.
How Much You Need to Save to Retire in 5 Years
Let’s say you’ve decided how much income you want in retirement, and run the numbers to calculate a target nest egg. You want to reach it in five years, then storm out of your workplace and retire.
For the next five years, you invest all your savings in an index fund that mimics the S&P 500. The S&P 500 has returned an average historical return of around 10% since its inception in the 1920s, so we’ll use that to calculate your future returns between now and retirement.
Here’s what you’d have to save and invest each month in order to reach the following target nest eggs in five years:
$500,000: $6,457 per month
$1 million: $12,914 per month
$1.5 million: $19,371 per month
$2 million: $25,827 per month
$3 million: $38,741 per month
So, could you retire in five years? You’d have to earn a pretty penny, and invest the bulk of it, but it’s theoretically possible.
How Much You Need to Save to Retire in 10 or 15 Years
Although still a challenge, it’s more feasible to retire in 10 or 15 years.
Here are the same numbers, with all the same assumptions, to retire in 10 years:
$500,000: $2,441 per month
$1 million: $4,882 per month
$1.5 million: $7,323 per month
$2 million: $9,763 per month
$3 million: $14,645 per month
If you give yourself 15 years, the numbers get even more feasible, although waiting 15 years starts to feel pretty remote to most of us. Here’s how much you’d need to save and invest each month to retire in 15 years:
$500,000: $1,206 per month
$1 million: $2,413 per month
$1.5 million: $3,619 per month
$2 million: $4,825 per month
$3 million: $7,238 per month
Financial Independence vs. Retiring Early
Financial independence means being able to cover your living expenses with passive income from investments (read: work optional). Retiring early means quitting your job and no longer working.
Responsible adults need to be financially independent in order to retire, but they don’t need to retire just because they reach financial independence. Because let’s be honest, as much fun as sitting on a beach sipping margaritas is, it gets boring after a week or two. Most of us don’t actually want to retire at 30 and never work again — we want the freedom to do work we love, even if it doesn’t pay well.
So, don’t get hung up on the “retiring young” component of the FIRE movement. Instead, focus on boosting your savings rate, investing to build your net worth quickly, reducing dependence on your job, and using your financial heft to help you design your perfect life. In other words, use FIRE tactics to help you with lifestyle design.
People love to criticize the FIRE movement for promoting laziness and encouraging young people to quit the workforce. In truth, the FIRE movement uses the “retire early” angle as a marketing gimmick, because everyone can intuit what that means. Most people don’t know exactly what “financial independence” or “lifestyle design” mean, so they make poor rallying cries.
But they’re where the meat of the FIRE movement lie.
Controversies and Criticisms of Extreme Early Retirement
Retiring young comes with real risks and downsides. Here are a few of the most common critiques of the concepts underlying the FIRE movement and early retirement in particular, along with my take on them.
Sacrifice, Delayed Gratification, and Low Quality of Life
Most middle-class people don’t want to live on $7,000 per year, and wonder why anyone would. They don’t want to sacrifice anything from their current quality of life.
Fisker addresses this issue at length in his book, which outlines not only the math behind his retirement strategy, but also the philosophy. In addition to extreme savings, Fisker recommends that a simpler lifestyle can create greater happiness. Forcing yourself to leave consumerism behind can help you learn how to be happy without constantly spending money.
My Take: The average person approaches every financial decision — from buying houses and cars to creating their budget — with the question, “What’s the most I can afford to spend?”
It’s the wrong question.
Instead ask, “What’s the least I can spend and still be happy?” Do you really need that giant SUV, that large suburban house? Does every adult in your household need their own car?
My wife and I no longer have a car at all. Or a housing payment, for that matter, as we found a way to house hack. We walk, bike, or Uber everywhere — and chose our city and home specifically to make that feasible.
You can frame budgeting and spending less as “sacrifice” or “minimalist” if you want. I don’t. I enjoy learning how to cook gourmet meals at home, enjoy using my own legs to get around rather than munching doughnuts behind the wheel of a car.
It’s all in your perspective. From my perspective, I live a fun, adventurous life making fast progress toward financial independence.
Health Insurance Is Expensive Without Employer Coverage
How can you possibly pay for health insurance without employer coverage?
Actually, many Americans get health care coverage without employer-sponsored insurance. But it does represent an additional expense for some early retirees.
When it comes to health insurance, Fisker recommends a high-deductible HSA-compatible plan to cover expensive medical emergencies. He also suggests maxing out contributions to an HSA until the account covers the high deductible on the plan.
My Take: Worst case scenario, you simply budget for health care as a living expense in retirement.
But you have plenty of other options as well. My wife and I live overseas, where health care costs less and we’ve never experienced lower quality care than we had in the U.S.
Or don’t stop working — just switch to a career you love that, ideally, includes health insurance. You can also look for a low-stress part-time job that offers health benefits.
Children Also Cost Money
It costs money to raise a child.
A study by the USDA estimated the average cost to raise a child at $284,570, factoring in inflation. That figure does not include college costs.
Critics contend that the FIRE movement ignores children, and early retirement is only attainable for people without kids.
My Take: First of all, children are an investment, not an expense. And I mean that not just figuratively, but also financially. My children are my insurance against superannuation: if I run out of money in retirement, my children can take me in or otherwise help with my care.
Fisker suggests keeping the costs of raising a child down by not giving them an allowance, encouraging them to save whatever money they get as gifts, buying children’s clothes at thrift stores, and encouraging them to go to a state school instead of an expensive private university. I don’t think you have to do any of that.
Nearly one-third of the cost of raising a child comes from larger housing. But you can avoid paying for housing through house hacking.
I have a child and hope to have a second, and still plan to reach financial independence within five years of when I started taking it seriously.
As for college education, there are many creative ways to help your kids pay for college. None of which require bankrupting yourself.
Only Single/Married/Rich/Educated/Privileged People Can Retire Early
The details don’t matter. The argument simply goes, “That other type of person might be able to retire early, but I can’t because I don’t have the advantages that they have.”
Single people say only married couples can achieve FIRE because they can share expenses. Married couples say only single people can achieve FIRE because they don’t have to worry about a spendthrift spouse. Which one is right? Neither, of course.
Everyone says, “Only people who earn more money than I do can achieve FIRE.” This pattern emerges no matter how much money they actually earn, because as they earn more, they simply spend more, in the never-ending cycle of lifestyle inflation.
And so it goes.
My Take: The average person stays average because they continue spending nearly every dollar they earn. They justify their lack of savings by saying, “I can’t save any more money, because I don’t earn enough. If I earned more, of course I’d save more!” Then when they get a raise, they immediately start spending more.
If you put all your considerable will into retiring young, you’ll find a way to do it. Most people don’t want it enough to do so, so they dismiss the entire concept as impossible.
It’s quite possible — but it does require tradeoffs that you may not be willing to make. Fisker lives on $7,000 a year, after all.
Extreme early retirement makes for a sexy concept, but it’s all sizzle and little steak.
The real meat lies in more nuanced and mature concepts like lifestyle design. Learn how to live a happy, meaningful, fulfilling life without spending as much money. Save and invest more of your earnings to build wealth and passive income faster. Find work that you love, regardless of the paycheck.
The more the average person earns, the more they want to earn. There’s no such thing as enough money — people climb onto the hedonic treadmill and run ever faster, exhausting themselves chasing more-more-more. A bigger house. A flashier car. Trendy clothes. A second home. Ever more status symbols to show the world how successful you are and how great your life is.
But when you start looking at your life holistically, through the lens of FIRE and lifestyle design, your perspective shifts. The more wealth and passive income I accumulate, the less I need to earn. And the more free I feel to spend my waking hours doing, well, whatever I want.