At the mention of retirement, most of you would probably envision the same – aged 60 or 65 years. This is no surprise. Retirement has long since been associated with old age, i.e., 65 years onwards. Thinking about early retirement is a novel concept.
However, with millennials and the newer generations, the concept of old-age retirement is now undergoing a change. Thanks to the new concept of F.I.R.E., many millennials are thinking about retiring early so that they can live the rest of their lives free from the monotony of a 9 to 5 lifestyle. Do you know what F.I.R.E. is all about?
The concept of F.I.R.E.
The full form of F.I.R.E. is ‘Financial Independence, Retire Early’. The concept was introduced in the book titled ‘Your Money Or Your Life’ by Joe Dominguez and Vicki Robin. Though the book was published in the year 1992, the F.I.R.E. movement gained traction years later. Today, however, many millennials follow the F.I.R.E. method and seek retirement years before the traditional time at which people retire, even as early as their late 30s or early 40s.
But what is the F.I.R.E. method all about?
The F.I.R.E. method involves wise financial decision-making to create a corpus that is sufficient enough to allow you to retire early. Under the F.I.R.E. method, emphasis is given to saving, investing, and limited spending so that you can create a substantial corpus early on. This corpus would then allow you to live out your retirement as a financially independent individual.
But how does this method work? Let us find out.
How does the F.I.R.E. method work?
For the F.I.R.E. method to work, you would first have to assess the retirement corpus that you need to accumulate. Estimate your needs and lifestyle requirements and arrive at a figure. When you know the absolute figure, you can build an investment strategy that allows you to achieve your calculated corpus.
So, how do you find the amount of corpus you need?
A very commonly used thumb rule to find out this is the 4% rule. The rule states that your annual expenses should equal 4% of the corpus you wish to accumulate. So, for instance, if your annual expenses amount to Rs. 12 lakhs, you need a corpus of Rs. 3 crores. Alternatively, if you accumulate a corpus of Rs. 3 crores, your annual expenses should be limited to Rs. 12 lakhs.
The 4% rule can give you a general estimate of the corpus needed. It is, however, not absolute. This is because the rule does not factor in inflation. Inflation would increase your expenses after retirement and you, thus, need to add inflation to the equation too.
So, work out a corpus using the 4% rule but try and save a higher amount to factor in the inflated costs post retirement.
Now the question arises – how early can this method help you retire? Will you be able to retire as soon as you are 40? Let us find out.
How to use the F.I.R.E. method to retire at 40?
Wondering how the F.I.R.E. method can help you retire at 40?
Well, there are some simple tenets of the method that, when applied, can help you accumulate a good corpus and retire at 40. These tenets are as follows:
What do you need to create a corpus? Save, what else!
Aggressive savings are required if you want to build up a corpus that is sufficient enough to last your lifetime when you retire at 40. So, try and save 70% to 80% of your income every month and set it aside for building up your retirement corpus.
If, after meeting your expenses, saving such a considerable part of your income becomes challenging, there is an alternative. Look for a supplemental source of income. Start a side job to boost your aggregate monthly income. There is also a concept of passive income, i.e., income that you earn without working for it. Common examples of such passive income include dividends from your investments, rent from a rented-out property, income from a blog, interest income from your deposits. Try and maximise this passive income which would boost your overall income. Then you can set aside 70% or 80% of the aggregated income for retirement after meeting your lifestyle expenses.
Many followers of the F.I.R.E. concept measure their probability of an early retirement by calculating a financial independence (FI) ratio using their passive income. The ratio is calculated as follows:
FI ratio = (passive income earned / monthly expenses) * 100
For instance, say you earn a passive income of Rs. 50,000 and your monthly expenses are Rs. 40,000. The FI ratio would then be:
FI ratio = (Rs.50,000 / Rs.40,000) * 100
According to the F.I.R.E. concept, a ratio higher than 100% is good. It shows that you can achieve financial independence and retire early.
Since expenses determine your ability to save, it is important to cut them down. This is, thus, the second and the most important tenet of the F.I.R.E. method. Even the FI ratio increases if you reduce your expenses.
To cut down on your expenses and spend frugally, here are some tips that might help:
- Plan a budget at the start of the month and stick to it at all costs. Do not go over your budget at any point of time.
- Try to limit your expenses by looking for cost-effective alternatives. For instance, if you need a car, opt for a second-hand car to get a lower price. Try to cycle or walk your way to work to reduce fuel costs or you can also use public transportation.
- Say ‘no’ to any unnecessary expenses.
Only saving your money is not enough. You need to invest it if you really want to grow your corpus. Investments give returns that help your corpus grow with time. So, after you save, put your savings in suitable investment avenues.
When it comes to choosing investment avenues, you need to be careful. Choose avenues that suit your investment strategy and match your risk profile, while also bringing you closer to your financial goals. Some of the available options that you can consider are:
- Mutual funds
- Exchange Traded Funds (ETFs)
- Fixed deposits
- Public Provident Fund
- Real estate
Understand the characteristics, limitations, and risks associated with each avenue. For instance, if you have a high tolerance for taking on risks, stocks and mutual funds can deliver attractive returns on investments. However, if you are risk-averse, you can consider fixed deposits or PPF schemes.
Invest every month, regularly. Step up your investments to supplement your retirement corpus continuously. You can start a Systematic Investment Plan (SIP) where you invest a set amount of money every month in a preferred investment. Have a disciplined savings approach so that your corpus starts growing even when you are working your way towards your retirement fund.
How can you retire with financial independence when you have pending debts to service?
Debts eat into your accumulated corpus and so, it is important to pay them off before you retire. This would serve two purposes. One, you would be free of your liability and can retire with peace. Two, your retirement corpus would be spared the debt burden.
So, if you have current loans, pay them off before you retire. If the loans are long-term ones, like a home loan, make prepayments to bring down the outstanding liability. Then you can pay the loan prior to retirement and become debt-free.
To get more tips to retire early, read our article ‘Grow old rich. Start today.’ on the Teji Mandi blog.
Calculating the corpus and following the aforementioned tenets might help you accumulate a sufficient fund and retire at 40. However, there are other aspects of the portfolio that you should keep in mind while employing this strategy. Let us have a look.
Things to keep in mind while employing the F.I.R.E. method
Apart from the above-mentioned points, you must also keep these aspects in mind while planning your expenses and investments:
- Emergency fund
An emergency fund is a must when you are planning your finances because emergencies can strike at any time and disrupt even the best-laid plans. So, set aside 3 to 6 months’ worth of your income in an emergency fund that can be easily liquidated. Life and health insurance plans are also important additions that take care of some of the major financial emergencies.
- Portfolio diversification
When picking investment avenues, do not play favourites. Pick different types of products to have a diversified portfolio that mixes both equity and debt. Even if you are risk-averse, have equity investments in your portfolio for capital appreciation. However, have a limited exposure to managing risks. Also, give your investments time so that their volatility gets evened out and you can enjoy attractive returns.
Understand the intricacies of portfolio diversification in our article on stock investing in India – what is diversification of portfolio? – read more on the Teji Mandi blog.
- Regular review
Just creating a financial portfolio does not ensure that you would be able to retire at 40. You need to review the portfolio constantly to check if your financial plan is on the right track. Check your savings and investments after every 4 to 6 months. If there is a deviation, correct it. If there is any room for improvement, improve it. Keep a tab on your portfolio to ensure that you end up with the corpus that you have envisaged and retire early.
Employing the F.I.R.E. method is not easy. We accept retiring at 40 is not a piece of cake, but it is not unachievable either. Many individuals struggle with their retirement corpus even when they retire at 60 or 65. But with meticulous and extremely careful planning and financial proactiveness, it is possible to create a large enough corpus for an easy retirement, irrespective of the age factor. You have to follow the tenets of the F.I.R.E. concept zealously so that you can accumulate the corpus that would give you financial independence and allow retirement at 40.
So, understand what the F.I.R.E. concept is, how it works, and how you can use it to retire at 40. Even if it seems challenging, follow the tenets of the F.I.R.E. method to build yourself a considerable corpus. Then, you may choose to delay your retirement if you want, but you will have the option to retire early with financial independence and lead a comfortable life. The experts at Teji Mandi help you plan your investments keeping in mind your financial goals as well as your risk profile. With our portfolio management services, you can leave the worry of constantly tracking your portfolio on us. Reach out to us through our website to manage your funds today and grow a sufficient corpus to have a secure and comfortable post-retirement life!