What is FIRE (Financial Independence, Retire Early) Movement? | Investment Series

1. What is FIRE?

FIRE, which stands for "Financial Independence, Retire Early," is a lifestyle and financial movement focused on achieving financial independence and retiring much earlier than the traditional age of 65. The core principle of the FIRE movement is to aggressively save and invest a significant portion of your income, often 50% or more, to build a nest egg large enough to cover your living expenses for the rest of your life.

Key principles and concepts of the FIRE movement include:

• High Savings Rate: The central idea is to maximize the gap between your income and your expenses. This is achieved through a combination of living frugally, minimizing unnecessary spending, and sometimes increasing your income through side hustles or higher-paying jobs. The more you save, the faster you can reach your goal.

• The "FIRE Number": This is the target amount you need to save and invest to achieve financial independence. A common rule of thumb is to save 25 times your estimated annual expenses. For example, if you plan to live on $40,000 a year, your FIRE number would be $1 million ($40,000 x 25).

• The 4% Rule: This is a withdrawal strategy often used by FIRE followers. It suggests that you can safely withdraw about 4% of your total savings each year in retirement, adjusted for inflation, without depleting your funds over a long period (typically 30 years).

• Strategic Investing: Simply saving money isn't enough. The money saved is typically invested in assets like low-cost index funds, stocks, and real estate, to generate passive income and grow over time through compound interest.

There are also several variations of FIRE that cater to different lifestyles and goals:

• Lean FIRE: This is for those who are willing to live on a very modest budget in retirement. It involves extreme frugality both during the accumulation phase and in retirement, allowing for a smaller FIRE number and a faster path to independence.

• Fat FIRE: This approach is for individuals who want to maintain a more comfortable or even luxurious lifestyle in retirement. It requires a much larger nest egg and a higher savings rate, often supported by a high-income career.

• Barista FIRE: This path involves saving enough to cover your basic living expenses but continuing to work a part-time or low-stress job to cover discretionary spending or to maintain health insurance benefits.

• Coast FIRE: This strategy focuses on saving a substantial amount early in your career, enough so that your investments will grow on their own through compound interest to a full retirement sum by a traditional retirement age. After reaching this point, you can "coast," reducing your work hours or taking a lower-paying job without needing to save any more.

The ultimate goal of FIRE isn't just about quitting your job, but about gaining the financial freedom to choose how you want to live your life. This could mean pursuing passions, spending more time with family, traveling, or working on projects you find fulfilling without the pressure of needing a paycheck.

2. The FIRE Number

The FIRE number is the central, most critical metric in the Financial Independence, Retire Early movement. It represents the total amount of money you need to have saved and invested to be considered financially independent. Reaching your FIRE number means that your investment portfolio is large enough to generate enough passive income to cover your living expenses for the rest of your life, without you needing to work a traditional job.

How the FIRE Number is Calculated: The 25x Rule

The most common way to calculate your FIRE number is by using the 25x rule, which is directly tied to the 4% rule.

The formula is:

$$\text{FIRE Number}=\text{Annual Expenses}\times 25$$

Here's the breakdown of this formula:

1. Determine Your Annual Expenses: This is the most crucial step. You need a realistic estimate of how much you will spend per year in retirement. This is not necessarily what you spend now, as your expenses may change. For example, you might no longer have commuting costs or work-related expenses, but you might plan on spending more on travel, hobbies, or healthcare. A thorough budget is essential to get this number right.

2. Multiply by 25: This is where the 25x rule comes in. The number 25 is the reciprocal of the 4% safe withdrawal rate (SWR), which is the other half of this equation.

The Connection to the 4% Rule

The 25x rule is a direct result of the 4% rule, which is a popular retirement withdrawal strategy. The 4% rule originated from a 1998 study by three professors at Trinity University. The study found that a retiree could withdraw 4% of their initial portfolio value in the first year of retirement, and then adjust that amount for inflation each subsequent year, with a very high probability (over 95% in most historical scenarios) of the portfolio lasting for at least 30 years.

• If you can safely withdraw 4% of your portfolio each year to cover your expenses, then your portfolio needs to be 25 times your annual expenses.

• Why? Because $1/0.04=25$. It's simply the inverse of the withdrawal rate.

For example, if you determine your annual expenses in retirement will be $50,000, your FIRE number would be:

$$\text{FIRE Number}=\$50,000\times 25=\$1,250,000$$

Once you have a portfolio of $1,250,000, you can theoretically withdraw 4% of that amount, or $50,000, in the first year. In the following years, you would adjust that $50,000 for inflation, and the portfolio's growth is expected to keep pace, allowing the money to last indefinitely.

Factors That Influence Your FIRE Number

While the 25x rule is a great starting point, it's a simplification. Your actual FIRE number may vary based on several factors:

• Lifestyle: As mentioned, your desired lifestyle in retirement is the biggest variable. A "Lean FIRE" lifestyle will have a much smaller FIRE number than a "Fat FIRE" one.

• Time Horizon: The 4% rule is generally considered safe for a 30-year retirement. Since FIRE retirees are leaving the workforce much earlier, their retirement could last for 40, 50, or even 60 years. Some people in the FIRE community choose to use a more conservative withdrawal rate, like 3.5% or 3%, which would increase their FIRE number to about 28.5x or 33.3x their annual expenses, respectively.

• Other Income Streams: The calculation assumes your portfolio is your sole source of income. If you expect to have other income in retirement from sources like Social Security, a pension, or even a small side hustle, you can subtract that income from your total annual expenses before you calculate your FIRE number. This reduces the amount of money your portfolio needs to generate, thereby lowering your FIRE number.

• Market Conditions: The 4% rule is based on historical market performance. There's no guarantee that future market conditions will be the same. The sequence of returns risk—where a market downturn early in retirement could seriously impact your portfolio's longevity—is a significant consideration for early retirees.

• Inflation: The calculation assumes you adjust your withdrawals for inflation. You need to factor in the potential for rising costs when estimating your expenses.

3. The 4% Rule

The 4% Rule is a cornerstone of the FIRE movement and is a popular guideline for retirement withdrawal strategies. It provides a simple, yet powerful, framework for determining how much you can safely spend from your investment portfolio each year in retirement without running out of money.

The Origins of the 4% Rule

The rule is most famously associated with the Trinity Study, a 1998 research paper by three professors from Trinity University. However, the original concept was actually developed a few years earlier by financial advisor Bill Bengen. He wanted to find a "safe withdrawal rate" (SWR) that would allow a retiree's portfolio to last for a long period, even through market downturns.

Bengen and the Trinity Study researchers conducted a "backtesting" analysis. They simulated a retiree's portfolio using historical data from the U.S. stock and bond markets, going back as far as the 1920s. They tested different withdrawal rates and portfolio compositions (e.g., 50% stocks, 50% bonds) over various retirement lengths (e.g., 30 years).

The key finding was that, in almost all historical scenarios, a retiree who withdrew 4% of their initial portfolio balance in the first year and then adjusted that dollar amount for inflation each subsequent year had a very high probability (over 95%) of their portfolio lasting for at least 30 years.

How the 4% Rule Works in Practice

Let's walk through a simple example to illustrate how the rule is applied:

1. Calculate Your Initial Withdrawal: On the first day of your retirement, you calculate 4% of your total retirement portfolio.

   • Example: If your portfolio is $1,000,000, your first-year withdrawal is $1,000,000 x 0.04 = $40,000.

2. Adjust for Inflation: In the second year of retirement, you don't withdraw 4% of the new, potentially lower, portfolio balance. Instead, you take your previous year's withdrawal amount and adjust it for inflation.

   • Example: If inflation was 3% in the first year, your second-year withdrawal would be $40,000 x 1.03 = $41,200.

3. Repeat Annually: You continue this process each year, adjusting your withdrawal amount based on the previous year's withdrawal and the inflation rate.

The underlying assumption is that your investment portfolio, which is typically a mix of stocks and bonds, will generate returns over time that outpace your withdrawals and inflation, allowing the portfolio to maintain its value.

Key Assumptions and Limitations of the 4% Rule

While the 4% Rule is a powerful and widely used guideline, it's not a foolproof guarantee. It's a simplification based on specific assumptions, and it's important to understand its limitations, especially for early retirees.

1. Fixed Time Horizon: The original studies focused on a 30-year retirement. For early retirees in the FIRE movement, retirement could last 40, 50, or even more years. A longer time horizon may require a more conservative withdrawal rate, such as 3.5% or 3%, to increase the probability of success.

2. Historical Data: The rule is based on historical market performance, which has included periods of significant growth. There is no guarantee that future market returns will mirror the past. A prolonged period of low returns, especially early in retirement (known as "sequence of returns risk"), could significantly impact the longevity of your portfolio.

3. Fixed Asset Allocation: The original studies typically assumed a portfolio with a fixed allocation, such as 50% stocks and 50% bonds. Your personal risk tolerance and investment strategy may differ, and changing your allocation during retirement could affect the safety of the 4% rule.

4. Rigid Spending: The rule assumes a consistent, inflation-adjusted spending level. In reality, spending often fluctuates. Early retirees might have higher expenses for travel and hobbies in the "go-go years," followed by lower spending in the "slow-go years," and then higher costs for healthcare in later life. Deviating from the rigid withdrawal schedule, particularly in a down market, can increase the risk of depleting your funds.

5. Taxes and Fees: The rule does not explicitly account for taxes and investment fees. These costs effectively reduce your real withdrawal rate. When planning, you need to budget for these expenses out of your 4% withdrawal.

The 4% Rule in the Modern Context

For these reasons, many financial planners and FIRE enthusiasts consider the 4% rule more of a rule of thumb or a starting point for planning, rather than a hard-and-fast rule. Some people use more flexible or "dynamic" withdrawal strategies that adjust spending based on market performance. For example, in a year with a significant market downturn, you might choose to withdraw a smaller amount than planned to preserve your capital. Conversely, in a year of strong returns, you might allow for a slightly larger withdrawal.

Despite its limitations, the 4% rule remains a crucial concept because it provides a tangible and simple way to answer the most fundamental question of the FIRE movement: "How much is enough?" By understanding the rule and its nuances, you can determine your own personal FIRE number and create a more informed and realistic plan for achieving financial independence. 

4. FIRE Movement in Malaysia

The FIRE movement has a growing presence in Malaysia, with many individuals and communities adapting the core principles of aggressive saving and investing to the local economic context. While the fundamental concepts remain the same—high savings rates, strategic investing, and the goal of financial independence—the specific strategies and challenges are tailored to the Malaysian environment.

Here are some key aspects and examples of the FIRE movement in Malaysia:

1. Adapting the FIRE Number

The FIRE number is still calculated using the 25x rule, but the "Annual Expenses" figure is based on the cost of living in Malaysia, which can vary significantly depending on location.

• For someone aiming for a relatively lean lifestyle, an annual expense of RM36,000 (RM3,000/month) would require a FIRE number of RM900,000.

• For a more comfortable, "Fat FIRE" lifestyle, a target could be much higher, with some individuals aiming for over RM3 million to support a more luxurious life or to emigrate to a country with a higher cost of living.

• The discussion around what constitutes a realistic FIRE number for the Malaysian middle class (M40) is a common topic in local communities, recognizing that not everyone has a high-income career.

2. Local Financial Tools and Strategies

Malaysian FIRE followers leverage local financial products and systems to build their wealth.

• Employees Provident Fund (EPF): EPF is a major component of retirement planning in Malaysia. While it is not fully accessible until a later age, its competitive dividend rates (e.g., 6.30% in 2024) make it a crucial part of a long-term strategy. Some people consider their EPF savings as a "post-retirement bucket" to be accessed after age 62, while their other investments cover the "early retirement" period.

• Amanah Saham Nasional Berhad (ASNB) Funds: These unit trust funds are popular in Malaysia and are often used by FIRE practitioners to generate passive income.

• Property Investment: Real estate is a common investment strategy in Malaysia, with rental income being a key source of passive income to cover expenses.

3. Key Malaysian Voices and Communities

There are several prominent figures and platforms that have emerged to discuss and promote FIRE in Malaysia. These individuals often share their personal journeys and provide actionable advice tailored to a Malaysian audience.

• Bloggers and Influencers:

  • Dividend Magic: A popular blog that has been documenting one individual's journey toward financial independence since 2015. The author shares their investment strategies, portfolio updates, and life lessons, often focusing on the "Financial Independence" aspect of the movement.

  • Ringgit Freedom: Another notable blog that focuses on investing and personal finance. The founder, Gracie, has multiple FIRE targets and openly shares her plans for "Lean FIRE" and "Fat FIRE" in Malaysia and even overseas.

  • Ringgit Oh Ringgit: This is a personal finance blog that, while not exclusively about FIRE, provides practical advice on saving, budgeting, and investing in Malaysia. It is a valuable resource for anyone on the path to financial independence.

• Online Communities:

  • The r/malaysiaFIRE subreddit is a great example of a community where Malaysians discuss their FIRE journeys, ask questions, and share tips on everything from budgeting and investment strategies to the challenges of inflation and the cost of living.

4. Challenges and Considerations

The FIRE movement in Malaysia faces unique challenges that are frequently discussed within these communities:

• Inflation and Cost of Living: Rising prices, especially in major cities like Kuala Lumpur, can make it challenging to maintain a high savings rate and can push the FIRE number higher. This has led to discussions on how to adjust FIRE plans for persistent inflation.

• Ringgit Depreciation: The value of the Malaysian Ringgit can affect the purchasing power of savings, especially for those who plan to retire or travel abroad. This makes strategic investment in assets that can hedge against currency risk a critical part of the plan.

• Low Financial Literacy: As highlighted by institutions like EPF, many Malaysians have low financial literacy, which can be a barrier to adopting the aggressive saving and investing principles of the FIRE movement. This makes the work of local FIRE bloggers and communities even more crucial.

In conclusion, the FIRE movement in Malaysia is not a direct copy of its Western counterparts. It is a localized and evolving movement that adapts global principles to the unique economic landscape of the country, leveraging local financial products and addressing specific local challenges.

Reference Link:

https://www.youtube.com/watch?v=iJTMccKnjdo

Happy Investing! 😉