Before taking the decision to retire early individuals should ensure that they have enough money set up for their post-retirement expenses and monthly living expenses. F.I.R.E, which stands for "Financial Independence, Retire Early" is a financial rule for early retirement planning.
For many decades, retirement was always a milestone that occurred typically at the age of 60. However, this concept is now changing rapidly and an increasing number of people are considering early retirement. Many millennials are seriously planning to retire by 40 or 50. If this sounds like an appealing option to you, you’re in the right place. In this article, we explore the meaning of early retirement and discuss how you can create an actionable early retirement plan.
What is early retirement?
Early retirement is the decision to stop working or leave the active workforce before the traditional retirement age of 60 (or 65). People who choose to retire early should have enough financial security to support their lifestyle over their post-retirement years. The corpus accumulated must be enough to help the retiree live a comfortable life without needing any active employment.
Different experts recommend varying methods of developing an early retirement plan. Some strategies may work for some individuals better than others. Nevertheless, the FIRE method is a common benchmark strategy.
Is it possible to retire by 40 in India?
Retiring by 40 in India is challenging but not impossible. With careful planning and disciplined execution, you can retire by 40 with a corpus large enough to lead a comfortable life. Here is an overview of some of the strategies you can implement to get you closer to your goal.
- Start investing early to make use of the power of compounding.
- Maximise income by pursuing high-paying careers, building successful businesses, or creating passive income streams.
- Embrace minimalism and save aggressively through strict budgeting and cutting unnecessary expenses.
- Investing in a diversified portfolio of stocks, debt instruments, real estate, and other assets.
- Manage debt effectively by avoiding or minimising the use of high-interest debt.
- Keep lifestyle inflation in check by resisting the urge to increase spending as your income grows.
The FIRE model for early retirement
FIRE is an acronym for Financial Independence, Retire Early. It enables people to look beyond the conventional retirement concept and achieve their goal of early retirement in their 40s or 50s. The main principles of the FIRE early retirement plan include the following:
- Extreme savings
If you are following the FIRE method of early retirement, you need to save around 50% to 70% of your income. This means a substantial portion of your earnings must be saved rather than spent, so you can quickly accumulate a sizable corpus. - Frugality in spending
Alongside your savings, you must also ensure that you do not overspend or spend on discretionary items. This method of early retirement plan emphasises frugality and minimalism in living. So, you must focus on cutting down whatever costs can be eliminated. - Regular investing
The amount you save up should be smartly invested in a mix of different assets, so you can accumulate the corpus you need to retire by 40 or 50. Depending on your risk tolerance, you may choose market-linked investments ranging from index funds to international funds. - Prudent withdrawal
Once you accumulate the required corpus and retire early, you need to be mindful about the amount you withdraw each month. The 4% rule can help you here, where you withdraw 4% of your corpus in the first year and adjust this amount for inflation annually.
How the FIRE model can help you retire early?
The Financial Independence, Retire Early (FIRE) model can get you closer to your goal of early retirement. Let us look at some of the ways in which it can help.
- Setting clear goals
Setting clear and well-defined goals is the first step to achieving financial independence. The FIRE model helps you do just that. By encouraging you to build a corpus that is about 30 to 35 times your annual expenses, the method gives you a clear objective that you can work towards. - Increasing the savings rate
The FIRE model encourages you to save 50% to 70% of your annual income. This is significantly higher than what most traditional financial models and strategies advocate. Such aggressive levels of savings can accelerate wealth accumulation and significantly reduce the time to retirement. - Encouraging a frugal mindset
To be able to save 50% to 70% of your annual income, you must adopt a frugal lifestyle. To do that, you need to spend consciously and only on the necessities. Living minimalistically and within your means can boost your wealth creation potential and get you closer to early retirement. - Focusing on investing wisely
The FIRE model encourages investing in assets that can deliver passive income, which is crucial for early retirement. The goal of the method is to generate enough passive income to cover your living expenses. Achieving this objective is possible if you focus on investing in assets that can generate passive income, such as real estate, dividend stocks, and fixed deposits.
The math behind F.I.R.E method
Start by asking yourself two key questions: How much income will you need to maintain your lifestyle in early retirement, and when do you want to retire?
The timing question is usually easier to answer, so let’s focus on estimating the income needed for early retirement.
To figure out your required income, you’ll need to determine a monthly or yearly spending amount. A widely-used rule of thumb for this is the 4% rule.
What is the 4% rule?
According to the 4% rule, if your retirement savings total, say, Rs. 5 crores, you can safely withdraw Rs. 20 lakhs annually. Another way to use this rule is to work backwards: 4% inverted is equivalent to 25 times your first year’s withdrawals. This means your retirement corpus should ideally be 25 times your first-year expenses.
For example, if you need Rs. 10 lakhs in the first year of retirement, then 25 times that amount would equal Rs. 2.5 crores, which should be your target corpus. This rule was initially developed in the 1990s, based on assumptions specific to the United States, such as a 7% average annual portfolio growth rate, designed for a 30-year retirement span.
However, if you’re planning to retire early, say at 40 or 45, your retirement period is much longer, making 4% potentially too high. Moreover, the rule doesn’t account for inflation—especially in a country like India, where inflation rates are typically higher than in developed countries. Fortunately, you can adapt the 4% rule using a simple Excel sheet, factoring in inflation to suit your personal goals.
The goal here is to estimate your retirement corpus accurately. With the math clarified, let’s delve into each step of the F.I.R.E. strategy.