Is retiring in your 30s a good idea?

Peter Adeney worked as an engineer after graduating from college, saving and investing the typical 15% of his annual income for retirement. Adeney didn’t want to work 40 hours a week for the rest of her life.

Over time, he would gradually increase his savings to 75% of his annual income, which would allow him to retire at the age of 30. Adeney, also known as Mr. Money Mustache, is considered one of the pioneers of the ‘Financial Independence, Early Retirement’ (or FIRE) movement.

At first glance, FIRE may seem appealing: you cut back on lifestyle expenses, invest your savings in low-cost index funds, and sit back as you watch your retirement nest egg grow. If you’re lucky, you can retire well before your 60s (when you would normally start collecting Social Security benefits) and live most of your life without being tied to a 9 to 5 office job.

FIRE is an early retirement movement where people save aggressively with the intention of retiring in their 30s or 40s. FIRE is not for the faint of heart – you will need to invest more than half of your annual income and cut all your expenses.

In order to retire early, FIRE members adhere to the 4% rule, first developed by financial advisor William Bengen in 1994. The 4% rule suggests that people save 25 times their annual living expenses and withdraw only 4% of their retirement nest egg. , increasing only the amount to be adjusted for inflation.

For example, if your annual living expenses were $ 40,000 per year, you would need to save $ 1 million before you retire. The idea is that you could live on your investments indefinitely assuming that the annual returns on your well-diversified portfolio will be between 5% and 8% (the power of compound interest!).

There are also different types of FIRE. Lean FIRE enthusiasts choose to live as frugally as possible in order to retire early, then choose to spend less than the average retired American. Fat FIRE members live more generously in retirement and typically work in high-income industries like technology or pre-retirement medicine.

If you are planning on doing FIRE, consider that you will have less time to invest in retirement and that you will spend more time in retirement. This means that traditional financial advice, which suggests you save 15% of your annual income, is gone.

For Adeney, that meant saving 75% of her after-tax income. Kristy Shen and Bryce Leung, a couple who retired in their early 30s, saved 50-70% of their combined annual after-tax income.

Adeney chose to invest her money in index funds in addition to real estate investments. With index funds, you don’t buy individual stocks. Instead, you buy a basket of stocks meant to mimic the performance of a stock index like the S&P 500. Since index funds are not actively managed, they typically have low expense ratios and fees. (or the percentage of expenses to the value of all assets under management).

“My fund of choice in this area is Vanguard’s VTI exchange-traded fund, which I hold directly in one account, and indirectly through some ‘automated advisor’ services like Betterment in other accounts,” says Adeney. “I am also a fan of simple real estate investments as a means of building up wealth. I have had rental homes in the past and currently own both my main house and a commercial building in downtown my town… ”

Robo-advisers use computer algorithms to invest your money, usually in low-cost ETFs or index funds. They typically offer lower management fees or expense ratios than a traditional financial advisor.

Platforms like Betterment and Wealthfront allow you to choose your risk tolerance level and time horizon (or how long you’ll need your money) and will invest the money in a portfolio that aligns with your financial goals. It’s an easy way to invest your money on autopilot, whether or not you plan to retire early.

Recently, however, the sustainability of the 4% rule has been challenged by researchers at Vanguard. Bengen had developed the 4% rule in 1994 by looking at stock and bond returns between 1926 and 1992. But here’s the catch: Bengen’s expected retirement horizon was only 30 years and historical returns are not predictive. future stock market performance (the rule inflates the probability of future success because past returns on stocks and bonds were greater than future returns predicted by Vanguard’s model).

The researchers found that if you practiced FIRE and had a longer retirement horizon of 50 years, your odds of success (or your odds of running out of retirement savings before you die) would be only 36%. If, however, you have a more traditional retirement horizon of 30 years, your chances of success increase to over 80%.

Cutting expenses and saving more than half of your annual income not only requires an investment of money, but also a lot of time and effort.

“In order to reach FIRE, every area of ​​your life must support it, including your partner, children, hobbies, time, cash flow, housing, etc. And once you’ve reached FIRE you will always have to be very mindful of your money to keep on track, ”says Ashley Dixon, CFP at GenY Planning.“ Many life transitions are beyond our control and require money to sustain or overcome them. . “

When Select asked Adeney what he thought FIRE was a movement that excluded people with low incomes or who had significant financial burdens like a student loan, medical debt, and credit card debt, he said that the movement was not just focusing on early retirement. .

“What we’re really doing here is helping people prioritize their spending and become more mindful and efficient with every dollar, so that more is spent on the things that are important to them, and less. things like interest, payments, car depreciation or gasoline, ”says Adeney.

While FIRE may seem like an unrealistic goal to many people, the values ​​of investing for early retirement and being more aware of your expenses are easy to understand, whether you plan to quit your job and retire in the near future. thirties or forties. .

You’ll need to pay off your debt first and build up an emergency fund before you start thinking about investing. You should prioritize paying off high-interest debt, like credit card debt, before paying off low-interest debt, like student loans.

In the event of an unforeseen expense like a breakdown in your car or a layoff, you should be able to rely on your emergency fund to cover rent, food, transportation, and other expenses. Most experts recommend saving three to six months of living expenses in an emergency fund. A high yield savings account is a great way to store money for this purpose: you will get a higher interest rate than on a checking account and this money will be more accessible to you than on a brokerage account.

Dixon recommends that Gen-Zers and Millennials take advantage of their employers’ 401 (k) match and contribute to a Roth IRA. A Roth IRA has a tax advantage – your contributions will be taxed up front so that you can avoid having to pay taxes when you withdraw money in retirement (as many people are in a low bracket). higher taxation later in life). She suggests people move on, by first maximizing contributions to both retirement accounts and then starting to invest in a taxable brokerage account to cover unforeseen costs in the future.

While FIRE may not be a realistic business for many, investing for early retirement, reducing discretionary spending, and paying off high interest debt are ways that people can be more financially independent, even if they don’t plan to retire. take early retirement.

As Adeney says, “Of course the end result is excess money, and if you invest that money over time, eventually you will have the opportunity to retire earlier and never have to work again. But that’s just a side effect of living a better life in the first place. So I encourage people to think about doing things that are helping them live better right now. “