Early retirement and the 4% rule: How FIRE investors can succeed

Key points

• Defining what FIRE investing is.
• Explaining the 4% rule.
• Updates to the 4% rule for FIRE investors.
• Understanding other costs and considerations for early retirement.

What is FIRE (Financial Independence Retire Early)?

FIRE investors aim to save a big chunk of their income while they're working so they can achieve financial freedom at a younger age and enjoy a long, fulfilling retirement. They prioritize intense budgeting, saving, and wise investing to help reach their goal.

The FIRE movement helps people retire early, but it does have some limitations. First and foremost, it requires a lot of discipline and sacrifice, which can make your working years feel restrictive. After early retirement, health care costs can also be tricky, especially without employer coverage. And for those who earn a more modest income, achieving FIRE can be even more difficult.

It’s important to consider the differences in strategy for traditional retirees and FIRE investors. In terms of retirement timeline, traditional retirement typically occurs around age 65, while FIRE enthusiasts aim to retire much earlier, often in their 30s, 40s, or 50s. The savings rate during working years is another crucial factor; traditional savers might save around 10%–15% of their income, whereas FIRE investors often save 50% or more. Social security benefits play a smaller role in FIRE retirements because these individuals often work fewer years and may not qualify for the same level of benefits as those who follow a traditional path. Health care planning is also more critical for FIRE investors, as they need to ensure they have adequate coverage before reaching Medicare eligibility at age 65. Lastly, the importance of taxable accounts is heightened for FIRE investors, as they rely heavily on these accounts to generate income during their early retirement years, before they can access the money in tax-advantaged retirement accounts without paying penalties.

What is the 4% rule for retirement?

The 4% rule aims to help retirees find a safe withdrawal rate for each year in retirement. According to this rule, you can withdraw 4% of your total retirement savings in the first year and then adjust that amount for inflation in each subsequent year. The idea is that this withdrawal rate will help you maintain a steady income while minimizing the risk of running out of money, even if the market experiences ups and downs.

Updates to the 4% rule for FIRE investors

The 4% rule may be right for investors with a 30-year retirement horizon. But others, including FIRE investors whose retirement horizon could be 50 years or more, will have better odds of making their savings last by customizing the 4% rule using Vanguard's principles of investing success.

1. Estimate future returns using forward-looking predictions

The 4% rule was originally tested using historical data from 1926 to 1992. Relying on past performance can lead to overconfidence, so strategic market and economic forecasts are better for predicting future returns.

2. Set an appropriate retirement horizon

The 4% rule assumes a 30-year retirement horizon. For a FIRE investor, whose retirement might last for 50 years or more, a realistic time frame is crucial for setting accurate goals and calculating withdrawal rates.

3. Minimize costs

The 4% rule didn’t account for investment fees. Keeping costs low significantly boosts your chances of success.

4. Invest in a diversified portfolio

The 4% rule was based on U.S. assets alone. A diversified portfolio that includes international stocks and bonds can enhance your success rate regardless of your retirement horizon or goals. Your asset mix greatly influences your portfolio’s performance and risk exposure.

5. Use a dynamic spending strategy

The 4% rule uses a fixed dollar-plus-inflation approach, which can deplete your savings during market downturns. A dynamic strategy, where you adjust spending based on market performance, offers more flexibility and increases your long-term success. Set a spending ceiling and floor to manage income stability.

How much do I need to retire early?

The amount you need to save for retirement can vary significantly depending on your personal situation, your retirement horizon, and how much you anticipate spending in retirement. For example, you’ll want to consider your retirement goals and the lifestyle you envision, whether that includes jet-setting in style or staying home and spending time in your garden. Estimating your retirement expenses, including health care costs and the impact of inflation, is crucial. You should also factor in all sources of retirement income, such as Social Security benefits, pension income, and other revenue streams like rental properties or annuities.

By planning carefully and balancing these factors, you can better determine when you'll be able to retire comfortably. For more detailed guidance on what to consider, you can use Vanguard's retirement planning resource. Once you've figured out how much you need to save to retire early, these tips can help you get there.

Plan for health care costs

• Maximize health care savings. Staying healthy can reduce medical expenses and enhance your quality of life in retirement.

Achieving a successful early retirement

Success in retirement looks different for everyone, and how much you save plays a crucial role in achieving your personal definition of success. By anticipating and planning for both daily expenses and potential medical expenses, you can help ensure that your financial foundation is solid. Embracing the principles outlined in this article, such as the FIRE strategy, setting a clear vision, aggressively saving, investing wisely, and minimizing current expenses, can help you build the nest egg you need to enjoy the early retirement you've always dreamed of.