If someone can achieve financial independence and retire early, how can they do it?
There are many paths to FIRE and many strategies for generating passive income, but they all share common denominators. These are the key steps to follow.
Set a Passive Income and Expense Goal
To get anywhere, you must first know where you want to go. Set a passive income goal, starting with the least amount you can spend each month and still be happy. After achieving financial independence, you can always choose to continue working, earning, and generating more passive income.
As an example, let’s say you want $4,000 per month in passive income. Now that you have a goal, you can start figuring out how to reach it.
Set a high savings rate
The gap between what you earn and what you spend is one of the most critical numbers for building wealth, not just for FIRE. Find ways to spend less and save more.
In particular, three costs make up about 70% of the average American budget, according to the Bureau of Labor Statistics : housing, transportation, and food. These three expenses offer the greatest scope for savings.
For example, you could take a job that provides free housing to lower your housing costs. You can try one of these 10 ways to minimize your transportation costs. You can bring your lunch to work and save hundreds of dollars a month. There is always a cheaper, or even free, alternative to traditional spending. Look no further than these options to travel the world for free.
To reach FIRE in five to 10 years, aim for a savings rate of 50% to 70% of your income. It’s not easy, but if it were easy, everyone would work for five years and then retire.
Maximize your active income
The more you earn, the more you can save. Start working for that promotion or raise, find a better paying job, or even change careers to earn more.
And your earning potential doesn’t end with your full-time job. Look for side jobs to generate extra money. You can even turn your hobby into a profitable business.
The trick is to avoid lifestyle inflation and not spend more just because you start earning more. All of that additional income should go directly into income-generating investments.
Pro Tip : If you’re looking for a way to earn some extra cash, consider Instacart . With Instacart, you’ll earn extra income buying groceries for others. Since you’ll be able to set your own hours, you can work as much or as little as your schedule allows.
Invest for passive income
From dividends to rental properties, private notes, and art (yes, you can even invest in art through Masterworks ), crowdfunding websites like Groundfloor to bonuses, you have plenty of options for generating passive income.
Personally, I like rental properties for high-yield income and stocks for diversification and long-term growth. A huge advantage of rental properties is that you can leverage other people’s money to build your portfolio of income-generating assets.
For example, let’s say you take $25,000 and use it as a down payment to purchase a repairman for a rental property. You cover closing costs with a seller’s concession and finance renovation costs with a hard money loan. Upon completion, you refinance the property with a cheaper long-term mortgage and withdraw your original $25,000.
You now have a property that generates monthly income with no net cash investment on your part. You can repeat this process indefinitely, creating a new stream of passive income with each property. It even has a fun acronym in the real estate investing world: BRRRR, or “Buy, Renovate, Rent, Refinance, Repeat.”
Know your FIRE ratio
As they say in business, what gets measured gets done.
In addition to your savings rate, a crucial number to keep track of is your FIRE rating, also known as your FI rating. It is the percentage of your monthly expenses that you can currently cover with your passive income.
For example, if your monthly expenses add up to $4,000, and you currently have $400 coming from investments each month, you have a FIRE ratio of 10%.
When your FIRE rating reaches 100%, pop the champagne cork because you are financially independent. You can retire and not work another day if you want. Or you can keep working, either in your current career or in a fun, stress-free second career.
I also like to track my net worth via the YNAB budget app , though I recognize that it’s largely a vanity metric. For financial independence, your net worth is just as relevant as your ability to generate ongoing income for yourself.
Lastly, also keep an eye on asset allocation. At the start of your FIRE journey, your investment strategy should focus on growth regardless of short-term volatility.
After all, if the stock market drops 20% while you’re working, it’s not a problem, quite the opposite, since you’re buying rather than selling at this point in your career. But as retirement approaches, income stability and reliability become more important. Without your full-time job to pay your bills, you become vulnerable to chargeback stream risk.
Look for ways to reduce the risk in your stock investment portfolio as you approach retirement, regardless of your age.
Conclusions
When you retire young, don’t expect help from Social Security or Medicare. You won’t qualify for many years, if ever.
Of course, the purchasing power of Social Security benefits has been declining for decades, losing 30% between 2000 and 2020, according to The Senior Citizens League . And the Social Security Administration admitted in 2018 that its spending shortfall puts it on track for insolvency by 2034.
As for health insurance, if you retire young, you can exercise the same health insurance options as the self-employed.
A savings rate of 50%, 60% or 70% is not easy. It’s no fun driving a 10 year old beater while your friends drive brand new BMWs. But it’s a lifestyle choice based on priorities: Would you rather accumulate enough wealth to retire young, or would you rather spend most of your paycheck now?
There is no wrong answer. But those who are willing to spend less today can play tomorrow while their colleagues continue to work.
