So, what’s FIRE?
The abbreviation stands for Financial Independence / Retire Early.
What it represents is the state in which a person doesn’t have to rely on a salary in order to sustain his lifestyle and stops working. This occurs when a person’s passive income or investment returns exceed his monthly expenses.
For example, take a person owning a floor in a residential building. Let’s say he’s renting out 4 apartments, all paying him the equivalent of the minimal salary in the area he lives in. Then, he has a positive monthly cash-flow and can stop working – thus retiring (early).
Take another example of a person who built his wealth by working for 20 years, made good investing decisions, and now enjoys capital gains and dividends funding his lifestyle. That means that he’s not reliant on a salary and thus financially independent.
Another example would be a stay-at-home dad who made a social contract with his wife to split their responsibilities. He’d stay at home looking for the kids and doing chores, while she’ll be the one bringing the money. This is a speculative one, but his monthly expenses are covered and thus he’s financially independent.
Some people decouple the FI and the RE parts and continue working although they’re not dependent on the salary. These include people who are passionate about their jobs, have their own businesses, or increase their net-worth even further although they can leave at any moment. There are also people who officially retired, but still undertake some ventures they find appealing every now and then to support their retirement.
The term early retirement is a controversial one. There are people who claim that a person is not retired if he still earns money after resigning and there are people who claim that retirement means not having a traditional job.
My side in this debate is: none. It really doesn’t matter how you call it. What works is the only thing that matters. I’ll let the internet argue about it, but at the end, it’s just a terminology thing (a cause of lots of debates that lead nowhere).
There is not that much fuss about the term Financial Independence, though. That’s straight forward: being able to sustain a lifestyle without relying on a salary.
How to achieve FIRE?
The path to FIRE is discussed in depth in various post on my blog and throughout the internet. If I need to summarize it, it would be:
- Earn
- Save
- Invest
There is actually a blog called ESI Money, making use of the acronym in its name.
And I have posts covering the full spectrum – on how to save, how to build an emergency fund, acquiring financial intelligence, overcoming investing fear, negotiating a higher salary, financial mistakes and misconceptions, investing in the stock market, how to allocate your wealth, which strategies to use, how to approach buying a home, geographic arbitrage, how the economy facilitates growth, and when is enough AKA when can you actually afford to stop working.
But today we’re looking at the big picture. A high level overview of how to reach financial independence. And since it’s already clear that the goal is having a positive monthly cash-flow, let’s take a look at a few unofficial and open for extension stages of Financial Independence.
5 Stages of FIRE
Level 1) Financial Slavery
Excuse the strong language… Let’s actually try to understand where is it coming from.
This is a state where a person is literally drowned in his financial obligations and he’s almost not earning for himself. To give an example, this may be a person who has lots of debt, sucks at budgeting, and continues utilizing bad financial habits in his daily decisions.
This is even worse than “paycheck to paycheck”, as every second of this person’s working life is spend to somehow get his net-worth to 0. So he keeps working for the government, the banks, the credit card issuers, the loan originators, and friends and family who borrowed him money.
At this stage, taking a day off can cause this person’s world to collapse on his shoulders to a point of no return. The smartest thing to do here is approach paying off debt structurally by focusing on paying off the highest interest loans ASAP.
Until that happens, this person is literally owned by his employer. He has almost no power to have an opinion because that could literally mean watching his family starve.
Level 2) Financial Dependence
This state represents a person who is, as the title says, financially dependent.
In theory, it’s not that different than the previous level, with the only difference that this man is not drowned in debt, but still spends his whole salary before the next payday. Towards the end of each month he still has to be careful with his expenses, but is able to afford more than just the bare necessities.
However, that exact freedom is what motivates him to indulge into consumerism and various forgotten subscriptions. Developing better habits could improve his lifestyle, but he’s unaware and still without a tight grasp on his personal finance.
Actually, if he losses his job, he will also experience his world collapsing. The good thing is that it won’t be because of lack of money he owes, but just because lack of money. The way to approach getting to the next level is developing financial literacy, budget appropriately, and paying himself first.
This person is theoretically able to save money, but his bad habits prevent him of doing so, as he overspends thinking that the world will adapt to his behavior. This is a category where the majority of people live.
Level 3) Financial Stability
Financial stability is a state where a person is actually able to save money. But that’s not the only improvement of the previous level.
Not only that he is able to save, but also has an emergency fund set up and has a stable career that is funding his lifestyle. There needs to be a series of catastrophic events to crush this person’s world, because he built a financial shield that protects him of unexpected emergencies.
Although he still depends on his salary, he can afford to lose his job or take risks with his careers because:
- He has the means to support himself for a few months (maybe with the help of a working partner)
- He is qualified and confident that he is employable
This is where real peace of mind kicks in. But a person shouldn’t get too comfortable yet.
Yes, life is currently good at level 3, but remember the series of catastrophic events? Those actually do come together – although he has a good hedge against a job loss, this is not the best place to be in during a recession. A fast-paced market, a change in the economy, or even an interest rate hike can all destabilize this person’s world. Not necessarily destroy it, but shatter it for sure.
That’s why it’s important to continue (l)earning and managing spending. Starting to invest and thus employing his savings to work for him is the first step he can take to graduate to level 4.
Level 4) Financial Flexibility
Life is officially good. A person is sitting on a fat pile of FU money and has his wealth distributed into various asset classes, all yielding returns. What’s similar with the previous stages is that he is still in the wealth accumulation phase. However, this time he is not only relying on the income from his job. He earns additional income from the vehicles that facilitate this process, but he is not using this money. All the ROI is immediately reinvested and he continues to do monthly contributions to his portfolio with the surplus of his salary.
He earns more than he needs to sustain his lifestyle, he spends some, and saves the rest. His savings are then forwarded into the asset classes of choice and this is fuel for the self-supporting cycle allowing him to have no worries about his financial future.
There is one thing missing though. This person has most of the things figured out – he lives the blueprint of how to retire young. However, he is not there yet. His net-worth is simply still not high enough to completely stop working, so he still needs an income. But this is far from dependence.
For example, if he decides to take a year off work he can do it without blinking an eye. Many people actually enjoy this kind of lifestyle. Working part-time or only at certain parts of the year. Maybe taking some freelance gigs so they don’t start exhausting their investments. Some even adopt a nomadic lifestyle and leverage the geographic arbitrage opportunities available to them.
Although part-time is a nice option for many, there are the people who simply push through the last stages of wealth accumulation and build their portfolio to the target amount, allowing them to reach a complete financial freedom and never think of working for money ever again.
Level 5) Financial Independence
And we’re back at defining FI.
This is a state where a person is not reliant on a job to sustain his lifestyle.
How to start?
Interested? There are two things I’d advise you to do:
- (Practical) Maximize your saving potential
- (Theoretical) Learn – read, ask, research, and understand how other people did what you’re aiming to do.
Once you have a decent amount of savings (for example, if you can fund a year of expenses), the Become an Investor series can be a nice place to learn what you can do with your money. The post Inflation Explained is a place where you can learn what you shouldn’t do with your money.
And I’ll give you a fair warning: once you start reaching for FIRE there may be no going back.
Enjoy!
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