Beginning With 'FIRE' For Early Retirement

Nov. 05, 2018 4:01 PM ET12 Comments
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  • FIRE also known as Financial Independence Retire Early, espouses values of frugal living, saving bulk of your income, and investing that until its yield in perpetuity covers yearly expenditure.
  • A typical FIRE portfolio yield has to typical earn a spread over inflation, but that has not been well discussed online.
  • Protection is required since risks are taken to earn above inflation rate. Otherwise, FIRE retirees will dip into their investments and savings.

Reason for this article:

As I write, I am edging closer to parenthood, expecting my first child at the age of 37, and naturally beginning to plan ahead, both in terms of how I invest and how I save. The intention is obvious, to plan for the financial needs of the family and still maintain the goal of being able to spend more time in the growing up ages of 0 to 7 years with my son.

Having toyed around with the idea of an early retirement before age 45, my wife and I have been putting in between 40% and 60% of our income into savings but are still learning the ropes as a FIRE saver.

We are currently in our first year of this saving mentality and have been pleasantly surprised by the creative sparks that have added flavor to our lives, including picking furniture from the dumps, uncovering hidden gems at thrift stores and auctions, buying and selling second hand items essentially owning instead of renting stuff for short periods of time before selling them again.

However, while my freegan friend disagrees, there is a limit to saving. Living a freegan (free and vegan) lifestyle is like investing without leverage on a put option. Your upside is capped, and some freegans tend to have to put in effort to get something for free. An easy example is if you would like to get a free transportation to a friend's place, instead of driving or taking the bus, you take a walk or hitch a ride. The sacrifice is typically either effort, or time.

FIRE struck a chord with me when I learned about the 4% depletion rate, which technically could provide a yield to perpetuity. A simple understanding of this can be found on this YouTube clip below.

Essentially, the idea is that any person may retire when his or her lifestyle cost remain under 4% returns distributions (through dividends or interest) out of the entire portfolio value.

What is FIRE?

FIRE or Financial Independence Retire Early is a lifestyle decision of foregoing current luxuries or excesses and saving them up. In doing, so the FIRE saver would then get used to living on less (and hopefully innovate, create and thrive later on). At the same time, taking the savings to invest into a retirement nest egg.

Once this nest egg is large enough to yield a stable annual return adequate to cover yearly expenses, then in essence, a yield to perpetuity would be established, and that income generated should technically cover retirement needs for the rest of your life.

The Values of FIRE:

FIRE resonates with me personally. I have friends who are freegans and friends who live a frugal life, living well within their means and having a seemingly stress-free life. The joy and happiness I see in them that is attributed to firstly being less tied down by financial fears and then consequently being able to pursue their interests and aspirations.

Living in a cosmopolitan and fast paced city, these friends contrast with my peers many of whom are in banking or private equity investments living whom are faced with long hours, stress and a repeated cycle of spending money to buy sanity, enjoyment or pleasure, or to simply buy time.

At the same time, I had considered the potential risks involved with FIRE and the naysayers approach from an investment risk perspective and its consequential fears as a result of a steep market correction, yield performance under expectation and whether such a portfolio should be passive or active.

The FIRE Portfolio:

Essentially a FIRE Portfolio has two objectives depending on the stage you are in your FIRE lifestyle and your risk profile. The first portfolio, which is the one I am building currently, is one which is constructed to reinvest my savings while I work and build my FIRE asset base. The second portfolio would be focused on maximizing distributions but at as low a risk as possible and have portfolio asset value keep in pace with inflation which is important and to be discussed later. I shall call this the FIRE Lifestyle Portfolio.

The FIRE Building Portfolio:

I call this the FIRE Building Portfolio (and I hope it's not a fire in a building type of portfolio). Essentially this portfolio has to maximize total investment yield and to grow this portfolio as quick as possible. In terms of risk, one has to decide if the investment portfolio should be conservative, moderate or high risk. At the same time, the savings rate from your annual income would be deployed into the FIRE Building Portfolio.

To understand this better, there is a basic formula which determines your retirement age at specific yearly savings rate and re-investment rate.

In Mr Money Moustache's blog post (here), someone who saves 64% of his or her income will be able to retire in 11 years on an investment return on savings at 5% per annum. The actual calculator is simple and can easily be done here (Early Retirement Calculator).

Illustration courtesy of

As an example, after 13 years of saving roughly 40% per annum and reinvesting at 5%, this individual's net worth is $544,676 will distribute 4% in dividends and interest to cover his $20,0000 yearly expenses and have a remaining income of $1,787. Note that this is a simplistic illustration and depending on where you live, taxes vary. Think of the 4% distribution rate as net of expenses and costs, or imply taxes into the expense budget every year during early retirement.

My FIRE Building Portfolio has a target of 7 years which requires me to increase either my savings rate or be aggressive in my investment return and portfolio construction.

Using a benchmark of historical returns on the S&P 500 over the last 5 years would yield an annual return rate of nearly 14% for the SPY ETF. Using my average savings rate of 50%, that should give me 11.5 years to turn my FIRE Building Portfolio into a FIRE Retirement Portfolio, assuming I currently have no savings at all.

To be realistic, my retirement age target is subjected to market timing and the peak to trough cycles of the market. As a result of nearly 10 years post the last recession, a 14% annual return probably does not look realistic. At the same time, risk appetite is important.

I am a risk-taker given my accelerated target of 45 years to FIRE and as a result, I am looking at building a portfolio that is high yield and growth oriented, with a need for some active management in terms of selection and market timing. I am not assuming I am confident or more intelligent in being able to beat the market, but I am willing to take more risks to generate the returns while I continue to have a stable job supplemented by a high savings rate.

Taking a look through some freshly initiated stock selections, I am currently looking at speculative high yielding stocks with preferred dividends like BMW (OTCPK:BMWYY) and Bright House Financial (BHF) and speculative bets on stocks that have a role to play in the future, like Qualcomm (QCOM) with 5G infrastructure deployment. I implied on these investments as speculative bets. However, I do not refer to the individual stocks as speculative but rather as a retail investor, I may not have done full or adequate research into any one stock, but have decided to rely on analysts or a thematic belief to make an investment.

Other stocks recently initiated are banks such as badly beaten Deutsche Bank (DB) and ICBC (OTCPK:IDCBF) which is one of the largest banks in China which is trading at PE of only 5.2x (historical earnings). At the same time, it would take a long time before Deutsche Bank manages a successful restructure of its business (or go bankrupt), or for China banks to be adequately transparent in their balance sheet and NPLs such that the market values ICBC closer to international peers.

I also try to get market exposure in countries I believe are having a difficult time, such as Russia, through the Russia ETF (RSX). RSX yields 4.3% and has an expense ratio of 0.7%. At the same time, given Russia's economic and political risks, the RSX is currently valued at 7.1x historical PE and priced at 0.8x PB.

There are various strategies to building a portfolio and various approaches. Pick one approach that makes sense and resonates with your values and risk appetite, but as typical retail investors rarely perform a thorough research, bottom up selection may not work or outperform the market, but rather taking on more risks that we are unaware of.

As such, I find my portfolio construction process lacking structure, and so what I have done is to buy in to have skin in the game, but have only started initiating under 5% of my savings into these investments. Hopefully, I will learn as I grow more in touch with these stocks.

I try therefore to deploy bulk of my cash into other means to short term returns and although they do not earn much currently, I hope to deploy and fully utilize my cash gradually and during stressed conditions in the market. With a long enough portfolio horizon, hopefully I enter and exit through a business cycle, and can gradually build up an understanding for investing.

Market Timing

We are into the rising interest rate period in a typical economic cycle. While I am no economist, I generally would like to start deploying cash into the market when it corrects by -2 standard deviations from the average, which represents a significant market downturn.

BMW 5 Year Average PE and Standard Deviation

Source: Bloomberg

Take BMW for example which had an average of 8.6x PE over the past 5 years, and dropped to under 7x when I looked at the stock. I initiated a position on BMW's preferred dividend, given it traded at a discount to the ordinary share despite being in an industry caught in trade war issues and a future of autonomous vehicles and the sharing economy which probably would decrease demand in future. I speculated that BMW, as with Daimler, is already impacted badly enough to start initiating a small position.

Similarly, for the broader S&P 500, I would imagine doing the same. The plan is to invest 5% now to get acquainted with my portfolio stocks, and then invest in 4 equal measures of 20% through the business cycle upon reaching the -2 standard deviation mark until it corrects towards the mean where I will fully deploy the remaining funds. Eventually, the portfolio would end up looking like a 50% selection of shares and a 50% investment in the index.

Subsequent savings would be periodically invested regularly towards this portfolio.

The FIRE Lifestyle Portfolio:

If all things work out, I shall be posting an update at age 45 and the FIRE Lifestyle Portfolio will emerge. Intuitively, the FIRE Lifestyle Portfolio should be looking at earning a normal market return and yield over 4% while its asset base appreciates enough to cover inflation.

The portfolio will still be fraught with risks of a significant market correction and also of inflation eroding my purchasing power. Hence I do believe in diversifying widely in this portfolio and being exposed to ETFs that would provide normal returns. At the same time, the portfolio remains exposed to the business cycle and distributions will get cut. Retirees however frugal, would start dipping into their portfolio.

There is no risk avoidance except to adjust expenses or balance the income statement with some additional supplemental income. For those interested in other alternatives, Ray Dalio has an all weather portfolio, discussed on bloomberg here.

I suspect the risk of getting into the FIRE Lifestyle Portfolio does not end at market risks and inflation. I can imagine there will be other factors like unforeseen expenses requiring a draw down or redemption in funds, hence depleting the overall portfolio.

Hence an alternative could possibly be to adopt a buffer similar to the sinking fund approach for rainy days with an attempt to either have an additional or part time income or to imply that into the required expenses and set this aside annually at a risk-free investment rate for liquidity and stability. Think of this as an insurance policy.

I would perhaps start with a typical required amount ($544,000) in the example above and assume a max drawdown which you assume might occur given a typical market downturn like in 2009 which declined by 60% from its peak. Protecting the portfolio for a year given today's rate and volatility would be priced at $19.21 for the SPY December 2019 put option at a strike price of $275, which is a cost of roughly 4.2% of this value for 60% decrease in portfolio value which would be higher than my expected 4% distribution! To then further refine this, enhancements might be required like selling call options to subsidize the cost of protection, or simply to partially protect and absorb residual risks.

Another approach which I find simpler would be to assume that it takes 2 years for the market to recover from its trough and build in a cash buffer of 2 years worth of expenses ($40,000 based on illustration above), and then wait out the business cycle. The sinking fund could also be set aside for this purpose during the FIRE Building Portfolio stage. This would roughly require less than 1 additional year before transitioning to the FIRE Lifestyle Portfolio.

The typical market correction requires 684 days on average and the maximum period was an agonizing 2112 days in 1973.


Hence I am suggesting that while 2 years is typically adequate to wait out a bear market, a severe correction requires the FIRE retiree to hunker down and get a job or some form of income. The risks are still unavoidable, but can be managed.

In conclusion, I find the merits of planning my financial freedom to be extremely helpful because it started me on a thinking journey of how things could be better for myself and my family. While it may look exciting, this journey is fraught with uncertainty and risks, but life is essentially about taking risks and managing them, accepting things as they come and rolling with the punches.

This article was written by

Big Alpha Research profile picture
I invest for my retirement and I write to make myself think through why I invest. I hope to learn as I write so your feedback is essential to my financial freedom! I have just begun writing about investments and retirement planning and have started my personal log of where I feed ideas from on

Disclosure: I am/we are long DB, BMWYY, BHFAL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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