In the world of financial planning, FIRE is an acronym that stands for Financial Independence, Retire Early.
The concept was introduced back in the early ‘90s in the book ‘Your Money or Your Life’ by Vicki Robin and Joe Dominguez.
The premise was/is that by saving aggressively and living quite frugally, you can reach the nirvana of financial independence in a relatively short time. That is the point at which you no longer need to work – the money you earn from savings and investments will be sufficient to meet ongoing spending needs.
To many, this will seem an unrealistic pipe dream and also implicitly frames work as ‘bad’ – in reality, many people enjoy their jobs and the purpose this gives them. That said, I see more and more people in their 40s and 50s for whom financial independence or freedom is a core objective.
And for them, it’s not necessarily about ‘retiring early’ at least not fully. Rather, it’s about having the flexibility to do ‘what they want, when they want, and with whom they want’ – true wealth one might say.
Or in the context of work, it’s often about having the flexibility (and confidence) to be able to pursue so-called ‘recreational employment’, which typically involves less pay, but is also less stressful and more rewarding.
So how do we go about forecasting the point of financial independence?
Cashflow is key
Cashflow modelling combines your current financial position with various assumptions re: inflation, investment returns, income, spending, retirement date, etc., to project that position forward.
It helps visualise whether you’re on track to have ‘enough’ (income and liquid capital) to meet future spending needs and therefore maintain your desired lifestyle – to ‘live your best life’ so to speak.
In the context of FIRE, we can use cashflow to determine the approximate point of financial freedom.
As ever, this is best explained by way of an example:
Case study
- John is 50 years old and earning £200k a year,
- He’s currently spending £5k a month, which he expects will continue through ‘active retirement’. We model a moderation in spending in later life, to £3k a month from age 80.
- In terms of current savings, John has a pension worth £600k, into which he’s contributing £40k a year (split 50/50 employee vs employer); £250k in a stocks & shares ISA, into which he’s contributing £20k a year; and £50k in Premium Bonds. The pension and ISA return an average of 5% pa net of costs, the Bonds 3%.
- His main residence is worth £750k and he plans to downsize to one worth £600k shortly after retirement. He has no deb.
- His current plans are to retire at age 60. However, he confesses he’s somewhat “sick of the corporate world” and would love to step away earlier, potentially pursuing some form of ‘recreational employment’ instead.
Note, these figures are for illustrative purposes only and do not reflect actual investment returns, which can fluctuate and are not guaranteed.
Step 1 - Baseline ('do nothing') scenario
The first step is to consider John’s ‘baseline cashflow scenario’ – i.e. his projected financial position based on the above assumptions.
The chart below shows his projected liquid capital – those assets that are readily available to meet future spending needs, e.g. cash, investments and pension savings.
Maintaining positive liquid capital throughout implies that John won’t run out of money and can therefore sustain his desired lifestyle, defined as spending £5k a month to age 80, and £3k a month thereafter (otherwise, rising with inflation).
As you can see, his position is a strong one.
Under the assumptions stated, John is clearly on track to have ‘enough’. And bear in mind, he has c. £600k in property in addition to this, which could be used to release extra funds if required, either through borrowing or sale.
In fact, John is likely to have considerable excess which, in turn, would imply that there’s scope to bring forward the date of retirement.
Step 2 - Financial independence, retire early
We can now use cashflow to estimate the point of financial independence – where work becomes a choice rather than a necessity.
This can be reframed as ‘What is the earliest point John can retire, without depleting liquid assets during his lifetime (I conservatively model to age 100, to factor in some later life cost provision, but this can be adjusted if clients prefer).
Using the cashflow software, I calculate the point of financial freedom as age 55 and 2 months.
The impact on projected liquid capital is shown below:
The above is telling us that, John can afford to retire shortly after his 55th birthday and would still have enough income and liquid capital to sustain his anticipated spending needs to age 100.
Step 3 - Financial independence, recreational employment
The previous step assumed full retirement, but John might not want to retire fully. Instead, what if he plans to do something else – some form of ‘recreational employment’ that’s more flexible, enjoyable and potentially rewarding too?
John’s passion has always been cricket and he believes he could secure a coaching role at one of the local schools and village club, paying him c. £25k a year.
With that in mind, we model the following scenario – John partially retires from his corporate job at age 55 and 2 months (as per the previous scenario) but then takes up the coaching post shortly after, before full retirement at age 67 (coinciding with the commencement of his State Pension).
The impact on projected liquid capital is shown below:
With the additional income source, he’s now back to a position of having considerable excess which once again implies there’s scope to bring forward the date of (now partial) retirement even further.
In fact, using the cashflow software, I estimate he can afford to partially retire at age 53 and 4 months, some 6 years and 8 months ahead of the original plan.
Summary
- The first scenario shows John’s projected liquid capital, assuming he continues in his current role until age 60 and then retires fully. He’s on track to have considerable excess.
- The second scenario calculates the earliest (full) retirement date, without depleting liquid capital at any point before age 100. This is estimated at 55 years and 2 months, i.e. potentially extending John’s retirement by an extra 4 years and 10 months.
- The third scenario shows that retirement can be brought forward even further, to age 53 and 4 months, assuming John can secure some form of ‘recreational employment’ that pays him £25k a year (or just 12.5% of his previous earnings), and that he continues in this new role until the commencement of State Pension.
Conclusion
I appreciate a long blog this week but this is powerful stuff.
Most people believe financial advice is about investment selection and insurance, but in reality, this is ‘real financial planning’ – aligning your capital with what you want to achieve in life.
This sort of analysis can genuinely be life-changing (I’ve seen this first-hand), giving people the confidence to live their best lives, whether that’s stepping away from a job they’ve fallen out of love with, bringing forward the date of retirement, buying their dream house, making lifetime gifts to their loved ones safe in the knowledge they’ll have ‘enough’…the list goes on.
If you’re interested in your point of financial independence, please let me know.
Disclaimer: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only. Since I don’t know your specific situation, none of this information should be construed as tax or financial advice. It is not an offer to purchase or sell any particular asset and it does not contain all the information which an investor may require to make an investment decision. Although endeavours have been made to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. We cannot accept responsibility for any loss as a result of acts or omissions taken in respect of any articles.
