Understanding Your Financial Independence (FIRE) Number

The Financial Independence, Retire Early (FIRE) movement is about accumulating enough wealth so that passive income covers your living expenses, allowing you to stop working if you choose. Your FIRE number is the total amount of money you need to save and invest to achieve this goal.

How is the FIRE Number Calculated?

The most common way to calculate your FIRE number is by multiplying your annual expenses by 25. This is based on the "4% Rule" (or Safe Withdrawal Rate), which suggests you can safely withdraw 4% of your portfolio each year without running out of money.

Formula: Your FIRE Number = Annual Expenses × 25

Understanding the Safe Withdrawal Rate (SWR)

The Safe Withdrawal Rate (SWR) is the percentage of your investment portfolio you can withdraw each year without depleting your principal, typically adjusted for inflation. The 4% rule originated from the Trinity Study, which suggested that a 4% withdrawal rate had a high success rate over 30-year periods, even through market downturns.

While 4% is a common starting point, some people opt for a lower SWR (e.g., 3% or 3.5%) for added safety, especially if they plan for a longer retirement or are more risk-averse. A lower SWR means a higher FIRE number.

Step-by-Step Example

Let's walk through an example to calculate a FIRE number:

1. Determine Your Annual Expenses: Track your spending for a few months to get an accurate average. Let's say your current annual expenses are $40,000.
2. Choose Your Safe Withdrawal Rate: We'll use the common 4% SWR for this example.
3. Calculate Your FIRE Number: Divide your annual expenses by your SWR (as a decimal).
   $40,000 / 0.04 = $1,000,000
4. Your FIRE Number is $1,000,000. This means you would aim to accumulate $1 million in your investment portfolio to potentially cover your $40,000 annual expenses using the 4% rule.

Frequently Asked Questions (FAQs)

• Is the 4% rule guaranteed?
  No, it's a guideline based on historical market data. Future market performance, inflation, and personal spending habits can affect its success.
• What if my expenses change in retirement?
  Your FIRE number should be re-evaluated periodically, especially if your lifestyle or major expenses (like healthcare) change.
• Does my FIRE number include my home equity?
  Typically, your FIRE number refers to your investment portfolio that generates income. Home equity is usually considered a separate asset unless you plan to sell your home and live off the proceeds.
• What about taxes?
  The 4% rule generally assumes withdrawals are from tax-advantaged accounts or that taxes are accounted for within the withdrawal. It's crucial to consider your tax strategy in retirement.