The FIRE (Financial Independence Retire Early) community is really gathering momentum in the USA and the UK and yet, there is still a strange amount of resistance to the notion that one might not have to work until the age of 65 and be able to retire earlier, even much earlier in your early 30’s or 40’s so that you’d have time to raise a family.
What’s even stranger is that some of the most outspoken opponents of this idea are financial advisors. Hmmm…could they have a vested interest in people working longer to pad their own financial futures?
Yes! If you didn’t have to pay a mere 2% fee for someone to manage your finances, then you would need half the money and could retire much, much sooner.
Yes, shockingly true, but all simple math.
Let me explain why. There is something called the 4% Rule, which was calculated by William Bergen in an attempt to figure out how much money one could withdraw from an investment portfolio every year without running out of money in retirement. This is called the “safe withdrawal rate” so that your retirement pot is likely to last 30 years despite ups and downs in the stock market, based on maintaining a 50% stock/50% bond portfolio and this rule even allows annual increases for inflation.
It is this 4% withdrawal rate that determines how much money you need invested before you can retire.
You need an investment pot generating an income that would replace your current income or you could create other revenue streams such as rental, royalty, business income or pensions, annuities or Social Security to become financially free. (FYI I personally use a combination of all of these to be as diversified as possible.)
The goal of FIRE is to replace your income with passive revenue, freeing you to do what you love to do whether that is paid work, lollygagging around a beach somewhere or volunteering, etc. Now, my take on FIRE was to simply go right for the desired end result and find work that I love to do. Problem solved. But even so, I have to reckon that one day I might not have the brains to coach people and will need other assets that provide an income, hence the need for a Financial Independence Plan even if you love your job and plan to carry on working. And, in my own case, I love to travel around the world, so am planning to do more of that when the kids are off to University.
A Seemingly Small 2% Fee Doubles the Amount You Need to Retire (and postpones financial independence)
Let’s say you would like an annual retirement income of $54,000, which is the average US income.
Based on the 4% rule, to withdraw $54,000 a year (the current USA average salary), you’d need $54,000 x 25 = $1,350,000 invested.
Now, let’s say you pay 2% annually in fees for someone to manage that pot of money for you. This means out of the 4% you can sustainably withdraw, you have to hand over half of that to your financial advisor/manager. Yikes! We don’t usually think of a 2% fee as being significant, but now you can see you are effectively giving your advisor a full 50% of your retirement investments.
In order to keep both you and your financial advisor in style, you’ll now have to either live on $27,000 a year instead of $54,000 or double the size of your investment pot to $2,700,000! Okay now we see why advisors would urge you to keep on working and saving longer, just to be safe. Ha!
Now if you can reduce the fees to manage your money (by going with low-cost indexed funds at Vanguard.com or similar), then you don’t have to save up nearly as much money and could conceivably retire much earlier. Well worth getting into some low-cost, no fee, funds as soon as possible! [Disclaimer: I use Vanguard.com but get no benefit from recommending this company as they do not have any affiliate program or commission payment even to their own staff. Truly an amazing company!]
Okay, so we now can very clearly see why most investment advisors would urge us to work longer, and generate a much larger retirement pot (just to be safe). But why would others object to the notion of financial independence sooner rather than later? I’ve come up with a few reasons why we might resist this whole conversation:
6 Reasons You Might be Resisting Financial Freedom
1. You don’t like thinking about getting older, being incapacitated either physically or mentally and unable to work, or about dying so naturally, you don’t plan for it.
This is actually fairly common. My dear mother-in-law refused to discuss anything related to death and as a result, we had no idea what she wanted for her funeral.
2. You might have emotional or moral inhibitors to amassing sufficient wealth to retire in comfort.
Beliefs that money is evil or immoral might prevent you from actively accumulating sufficient wealth to retire. You might have puritanical beliefs that idleness breeds evil and feel that you have to work until you drop dead. Did you choose this belief or was it something you grew up with? Why not choose something more empowering? Just remember, that while money may not be able to buy you love, it is good for groceries!
3. Maybe you’re a short-term or mid-term thinker.
While some people can visualize their long-term future (when I was in high school I had imagined my retirement owning a dude ranch in Arizona complete with a hot tub), most people have either a short or mid-range horizon for planning, meaning that it is hard to imagine anything more than five years in the future. Because we can’t visualize our lives in the future, we don’t plan for this life until it is too late. For this reason alone, I’m a big fan of keeping Social Security in place and doing whatever is needed to keep the system going strong.
The fact is most people aren’t great at really long-term planning. It is hard to get motivated to do something if you don’t feel the immediate pain or benefit. And, the problem with saving for retirement is that you don’t feel any benefit up front, only for some nebulous future later, but you feel all the pain of not having that money to spend now. No mystery why the average current retirement savings are woefully short of where they should be! The key is to trick yourself into being a better saver.
4. Some people don’t like math, while others feel fearful of numbers or lack confidence in anything that is related to numbers.
So they either don’t do anything or delegate the job to a financial advisor who does like to do it. But the financial advisor may not have your best interests at heart. (The solution is to make sure your financial advisor works on a fee-only basis, not a commission basis.) Thankfully, retirement math doesn’t have to be complicated as the really simple solutions are often as good, if not better than the complicated or more sophisticated solutions.
5. You might be resisting the fact that you are most likely over-spending or under-earning or both.
No one relishes the idea of having to spend less to save for a future we can’t even visualize. This is one of the good things about the F.I.R.E. conversation: by bringing the retirement deadline out of the very distant future into a more foreseeable future (10 or 15 years instead of 30 or 40 years), this alone can make something more real, exciting and tangible because very few people have a 30 to 40-year time horizon for planning. Their brains just don’t see that far ahead.
6. The lure of the now is simply too strong.
You have real needs that require money right now, such as the need to buy a house, a car, feed your family, pay off credit cards, pay for University fees, take the cat to the vet, buy new tires, fix the roof…..the list of your current financial obligations is huge and real. All of these expenses mean you have to put retirement on the back burner. You assume there will be time to catch up later, but there may not be. The solution is simple, but not easy. Allocate 20% to your retirement savings and then figure out how to do everything else. This will probably mean that you buy a smaller house than you would or a used car, but it will enable you to get your retirement savings on track.
Now that you might see why you might be putting off saving for the future, you can start by tackling the issue that is holding you back. If you don’t start with what you are resisting, you might find you never get around to saving for financial independence until it really is too late.
To learn more about financial independence, check out our FIRE course.