All of us in the FIRE community share a common goal:
To remove dependence from wage income as early in life as practical, so that we can pursue our passions without having to worry about money.
There are two main pillars to the FIRE movement:
- Upping your savings rate allows one to accumulate capital faster AND reduces the amount of passive income needed to sustain one’s lifestyle in early retirement.
- Accumulating enough wealth such that one can draw down their portfolio and sustain their desired lifestyle indefinitely, including through economic downturns.
There are many ways to accomplish these objectives, including by cutting back on spending, generating more income, investing, and creating assets like businesses. Everyone chooses the path that’s right for them.
Some of us use real estate as a tool on this journey, and many who do hang out here on BiggerPockets.
None of us could have predicted that the trigger for a decline in equity values, and potentially a real recession, was this coronavirus. But nearly everyone who takes the FIRE movement seriously has prepared aggressively for it all the same, simply by pursuing their goal of early retirement and building a retirement portfolio capable of navigating even the worst economic environments in modern history.
Which brings me to my point.
These arguments are simply wrong. They don’t really understand FIRE, and they don’t understand the math.
Folks who are part of the FIRE community, who aspire to retire early in life, aren’t just going away. This recession is not going to damage the FIRE movement—or even really slow it down.
Now, it will eliminate the people who don’t really believe in it. Those who don’t have the discipline to invest for the long-term and don’t understand the math that drives this movement. Folks who might rightly be called “fake FIRE.”
However, the entire point—the ENTIRE point—of the key tenets of the FIRE movement is to build a portfolio that can sustain one’s lifestyle even in the event of the worst economic conditions in modern history. The key tenet of FIRE—the 4% rule—has been backtested through the Great Depression, assuming you retired in 1929 (which, by the way, wasn’t even the worst year to retire in the last 100 years).
And even then, folks in the FIRE community are still more conservative.
Retirement Withdrawal Rates Explained
When we work toward retirement, we stockpile investments, usually in stocks, real estate, bonds, and cash. When we retire, we stop stockpiling those investments, forgo earning more active income to grow our portfolios, and begin to spend the income they generate and/or sell off portions of the portfolio over time to finance our lifestyles.
So, just how much of that income can you spend? Just how much can you sell year to year to ensure that you don’t run out of money?
What is the safe withdrawal rate for our retirement portfolio—a percentage of our wealth that we can draw down, year after year, and never have to worry about running out of money for the rest of our lives?
Well, the answer is a bit complicated. We can’t just spend the average expected return from our portfolios. If we do, we run into a problem called sequence of return risk.
Sequence of Returns Risk Explained
Assume that I invest $100 and forget about it. Ten years later, that $100 has grown to $200. As a long-term investor not intending to spend that money, I don’t really care how it grew.
I was never going to spend it!
That $100 could have actually dropped immediately to $50 right after I invested it and slowly increased to $200 in value over the next nine years. Or it could have grown immediately to $300 and then dropped slowly to $200 over the next nine years.
As a long-term investor, I don’t really care. I end up at $200 either way.
But as a retiree withdrawing continuously from my portfolio, I DO care about this a great deal. If, for example, the portfolio immediately drops in value, and I withdraw when it is low, then the remaining balance does not have the opportunity to compound in future years.
In other words, I may run out of money!
The point here is that I can’t spend the average expected return of my portfolio and expect to never run out of money. I can’t even spend less than the average return.
I have to spend a percentage of my portfolio that reflects sequence of returns risk in the worst-case scenario that is reasonable to plan for.
The 4% Rule: A SAFE Withdrawal Rate
An effective way to account for sequence of returns risk, and thus calculate a safe withdrawal rate on a retirement portfolio, is exemplified through the Trinity Study, or perhaps even it’s precursor, a paper by William Bengen. While the phrase “sequence of returns risk” is never explicitly used in these papers, effectively the study accounts for this phenomenon by backtesting portfolios and regularly drawing down on them to account for this risk.
There are myriad derivative works from this study. Two articles that I find even more helpful than the original study (or its precursors) are this article by Mr. Money Mustache and this one by Michael Kitces.
Using Michael Kitces’ article as a particularly thorough and data-driven example, he assumes that one’s portfolio is comprised 60/40 of large-cap stocks and intermediate corporate bonds. He then conducts a safe withdrawal analysis for the past 140 years.
Assuming a portfolio of 60 percent large-cap stocks and 40 percent intermediate-term government bonds, Kitces produces the following chart:
If one selects a random year to retire, then 50 percent or more of the time, they can actually draw down 6.5 percent or more of their portfolio and not run out of money over a 30-year period. In the worst-case scenario in the past 140 years, one would have had to draw down 4.5 percent or less of their portfolio each year to avoid running out of money over a 30-year period.
If one spends 4.5 percent or less of their portfolio, then in no 30-year period in the past 140 years would they have run out of money—including if they retired in 1929 right before the Great Depression.
In fact, 96 percent of the time, the retiree drawing down 4.5 percent of their portfolio would end up with MORE wealth after 30 years than they started with.
When you hear about the “4% rule,” you don’t have to have a Ph.D. in statistics and financial markets. You can understand, in a matter of minutes (or at most a few hours), that you are talking about a rule that has been backtested through hundreds of years. That accounts for the very worst-case scenarios in all of modern history.
While 30 years have not yet passed for those who retired in 1991 or later, there is very strong evidence that the 4% rule is holding up exceptionally well since the tech bubble and 2008 financial crisis.
There are some bozos out there who claim that the 4% rule does not account for sequence of returns risk. Naysayers and folks who are moderately lousy at math like to use the phrase “sequence of returns risk” to sound smart. They only betray their ignorance, and you, the reader, will never be fooled by them.
The nature of the math behind the trinity study and many derivative works used to calculate safe withdrawal rates is to systematically withdraw income and equity from portfolios to cover spending, after inflation, year by year over the last century or so.
This is literally, absolutely, definitively, mathematically accounting for sequence of returns risk.
If you still aren’t convinced, we had the privilege of interviewing Michael Kitces, author of much original research on this subject for over an hour last week. The interview can be found here: “Are FIRE Naysayers Bad at Math? Yes.”
Wrapping Up Safe Withdrawal Rates
One last commonsensical point I want to make here is the inverse math of the 4% rule. If you plan to withdraw from your portfolio at a rate of 4 percent, it’s the same thing as saying that you’ve built a portfolio that is 25X greater than your annual spending.
That means that, by definition, if you simply match inflation with your investment portfolio, your money will last you 25 years. You only have to beat inflation by a very, very small margin to not run out of money over a 30-year period if you have 25 years of spending saved up!
Folks in the FIRE community most often work toward a goal of retiring at the “4% rule,” whereby they plan to spend about 4 percent of their portfolio balance in the initial year, and increase or decrease spending in line with inflation thereafter. For the reasons discussed, this is an extremely conservative withdrawal rate. At the less conservative 4.5 percent rate, calculated as the absolute minimum over the past 140 years in Michael Kitces’ study, one does not run out of money in any period in modern history and one has a 96 percent chance of building more wealth over a 30-year period than they started with.
So, suppose that you FIRE’d at the 4% rule in February 2020 and watched the market immediately tank.
In this case, I hope it is clear by now that you are not falling out of FI. You have prepared for precisely this kind of event because you followed the 4% rule, which takes into account retiring just before a market drop—like this one. This is because the 4% rule accounts for sequence of returns risk.
The very best counterargument to the 4% rule is not that sequence of returns risk invalidates it. As we discussed at length, that is simply incorrect. The opposite is true.
The best counterargument is instead that it analyzes whether a portfolio of stocks and bonds runs out entirely over a 30-year period. This is an important consideration for someone FIREing early in life, who needs their money to last much longer than 30 years.
For example, a 30-year-old retiree who starts with $1M but depletes that to $10 by the end of 30 years is obviously in trouble. They didn’t run out of money in 30 years, but they aren’t making it through year 31. They’ll be 60 years old and out of money!
In a tiny fraction of historical cases, scenarios happen under the 4% rule where one’s position actually diminishes to the point where one ends a 30-year period with less principal than they started with.
There are two key points to address this small subset of outlier scenarios:
First, as we saw from Michael Kitces’ research, in 96 percent of cases one actually builds wealth at the 60/40 stock/bond split he or she uses over a 30-year period. So, the vast, vast majority of cases are going to avoid this problem entirely.
Second, the 4% rule assumes a robotic and consistent withdrawal rate. It takes no practical realities into considerations. To quote Mr. Money Mustache in his article on the same subject:
The Trinity Study [and most derivative works, like those of Michael Kitces] assumes a retiree will:
- Never earn any more money through part-time work or self-employment
- Never collect a single dollar from social security or a pension plan
- Never adjust spending to account for economic realities [like a quarantine]
- Never substitute goods to account for inflation or price fluctuations
- Never collect inheritance
- Never spend less as they age
I’ll add to MMM and point out that the Trinity Study and most derivative works also assume that the early retiree has no cash cushion or other liquidity outside of their stock and bond portfolios.
Simply by not being a robot and paying attention to spending, building a cash cushion into retirement planning, and potentially doing part-time work if you are one of the unlucky 4 percent, you can ensure that you will never run out of money in your long retirement.
STILL, the FIRE Community Is More Conservative Than the 4% Rule
The math is overwhelming. It clearly, clearly shows that the 4% rule is a perfectly conservative, appropriate, time-tested, sequence of returns-proof, sound retirement planning approach.
It’s nearly always good for a robot with no common sense whatsoever in the vast, vast majority of scenarios and mathematically takes into account sequence of returns risk.
It’s certainly appropriate and conservative enough for younger retirees who maintain any degree of flexibility and practicality whatsoever. So long as they apply common sense and make adjustments to their spending in the few unlucky scenarios where their portfolio may dwindle.
In spite of those considerations, I polled a FIRE community group a few months back. Of the people who have actually left their jobs and FIRE’d, less than 5 percent said that they planned for a supermajority of their income to come from stocks and bonds.
That’s right: 95 percent of those who have actually FIRE’d have significant income sources outside of their stock/bond portfolios. Not a single person in all the folks I’ve encountered is puritanically relying on the 4% rule with a stock/bond allocation and no cash to back it up.
Of the 5 percent who do rely predominantly on stocks and bonds, many are older relative to the FIRE movement (50+). They will likely be eligible for social security in a few years. All are more conservative than the 4% rule with their holdings. Some use a 3% rule or are even more conservative. Some have six-figure savings account balances.
To repeat—not a single person that I know of in all the thousands I have interacted with in the FIRE community relies on a stock/bond portfolio at the 4% rule with no cash, no other income expectations, no other substantial assets, etc. Perhaps the first person fitting this profile will respond in the comments to this very blog post. We’ll see.
But one could FIRE at the 4% rule with no cash savings. Or other income. Or social security.
And they’d still be conservative.
Even if they FIRE’d right before the coronavirus market drop.
If you are on BiggerPockets, you are likely using real estate as one of several wealth-building tools to derive financial independence from your job or simply build wealth with real estate in addition to other assets.
Real estate investors are often even more conservative than stock/bond investors.
They often “retire” only when they can live off a minority of their cash flow and exclude appreciation entirely. This is the equivalent of a stock/bond investor only living off of interest payments and dividends and not selling any equity interest. It’s more conservative than the 4% rule. And many of the investors on BiggerPockets have sources of income in addition to their real estate holdings.
The tenets of the FIRE community continue to hold up. And they are designed precisely to account for bad market conditions. This is what we plan for. This is the point of the 4% rule. But STILL, early retirees are usually much more conservative than that.
No one in the FIRE community assumes the best when they FIRE. They account for the worst. It’s perhaps the most conservative possible stance one can reasonably take, short of stockpiling wealth with no intention of ever spending it ad infinitum or planning for financial markets that are far worse than anything ever seen in history.
The FIRE community earns more than the average American. They often spend less. They invest for the long-term in appreciable assets. They have an investing philosophy and understanding about why they invest. They often have skills that give them income-generating capabilities outside their jobs. They often aspire to become entrepreneurs. They often have diversified portfolios. They plan their finances around the worst market conditions seen in the past 140 or so years, and then some.
They typically have excellent credit, a strong cash emergency reserve, and are at varying points of the progression in building multiple streams of income. They may own stocks, real estate, side businesses, or invest in alternative assets.
They almost never leave their primary source of income unless they have a position far more conservative even than the ultraconservative 4% rule. More and more of them are accomplishing this feat in their 40s, 30s, or even their 20s. These people are more flexible and can be more opportunistic, not less, than the ordinary person because of their position.
The remaining members of the FIRE community are still working toward the goal of early retirement. They are earning, spending little, investing, and trying out side hustles, entrepreneurship, etc. They are all at various points on the journey.
A recession may set them back, of course, in the short-term. It may disrupt income, it might reduce their portfolio size. It might make it harder to sustain their consistent patterns of wealth accumulation built up and maintained over several years.
After all, in a recession, prices of assets may fall. Incomes may fall.
But who, might I ask, IS in position to weather the storm? Who gets hit hardest?
It is the folks without savings, with poor credit, without alternative sources of income who will be hit hardest by the shutdown. By recessions. By depressions. Recessions and depressions are good for the net worth of very few folks. Almost no one likes a recession.
But the guy who comes through a recession, market drop, or depression in relatively good shape is the guy who spends little relative to his income, invests for the long-term, stays the course, and either has built, or is well along on his journey to building, a financial fortress.
And the lady who is already retired with an ultraconservative 4% rule or even more, having planned precisely for this kind of event? She is impacted the very least.
Sorry, naysayers. You are just plain wrong. The FIRE community is almost perfectly prepared for coronavirus quarantines and any simultaneous or downstream economic impacts like a recession.
That’s the point…
Do you think FIRE is still attainable? Why or why not?
Let’s discuss in the comment section below.