Before we get any further, we need to define the very thing we’re pursuing. FIRE or Financially Independent, Retired Early, refers to one simple concept: when your passive income matches your expenses and you no longer need to work for a living. To be clear, it doesn’t mean you don’t work at all; it means you don’t have to work.
Since there are thousands of different passive income streams, the route you take to reach FIRE may end up being completely different than the route we take.
Proponents in the FIRE space typically recommend the stock market route. Living off stock dividends and the occasional sale of shares is about as passive as you can possibly get when it comes to investing. It simply takes a few hours each year to re-balance and withdraw the necessary funds. But others may purchase buy-and-hold rental properties until they receive enough cash flow from these rentals to cover their expenses. Another may spend 5-10 years building a business and either sell it or collect owner draws that cover his or her expenses. There are many paths to FIRE. Each has its own benefits and drawbacks, but they all lead to the same destination.
So how do you determine which path to take? Let’s take a look at a few of the most common options:
1) The Stock Market Route
The stock market route involves purchasing shares in low-cost index funds. We recommend Vanguard index funds due to the ownership structure of the firm and their low costs, but Fidelity is also a great option. This road is a bit longer than real estate and starting your own business, but it stays true to its definition of a passive investment. You simply buy shares and collect dividends. Buying takes a couple of minutes once you get your account set up and dividends can be sent straight to your bank account or reinvested. We recommend reinvesting dividends until you have enough money invested to cover your expenses.
But how do you know how much you need to invest until you have enough to live off of? That’s when the Trinity study comes in. Three professors at Trinity University looked at historical data in 30 year periods starting in 1926 (so this includes the Great Depression!) They wanted to find out if a retiree would have any money left over if they took out a certain percentage of their starting portfolio balance each year, over a 30 year window. What they found is that if a retiree had an allocation of 75% stocks and 25% bonds and withdrew 4% of their starting balance every year, that they’d end up being successful 98% of the time. Not only this, but on average, their ending balance would be multiple factors of their starting balance. Because of the high success rate, it became known as the 4% rule. So once you have enough saved up so that 4% of it matches your annual expenses, you can consider yourself financially independent (or more colloquially, “FIRE”). How long it takes to get there depends on your savings rate, but this can easily become a mere 10 year journey for some people.
2) The Real Estate Route
Andrew Carnegie’s famous quote “90% of all millionaires become so through owning real estate” could not have been more applicable after the Great Recession. Once housing prices plummeted, a lot of people who decided to purchase property at the bottom of the market ended up quickly becoming very wealthy. While deals are harder and harder to find today, they are still out there. Even if you simply can’t find these deals right now, the real estate market is cyclical. Eventually things will bottom out again and those deals will come.
Buy-and-Hold real estate is considered the most passive of all real estate investment types. This involves purchasing a property and renting it out to a tenant, with the intention of keeping the property for the long term. It should have positive cash flow when you first buy it (your rental income should exceed your rental expenses, including vacancy and capital expenditures like the occasional roof replacement), and when your mortgage is paid off it will become a cash cow. Real estate has this beautiful quadruple effect of leverage, appreciation, principal payoff by renters and cash flow that allow investors to quickly become financially independent. Several investors see cash on cash return equaling market return before all these other benefits are added in. So why wouldn’t you want to invest in real estate? The major problem with real estate is that it’s not really passive. You must find the deals, purchase the property and even if you use a property manager, you still have to manage the manager. So while returns can be fantastic, be prepared for a more hands-on investment. Once your cash flow matches your expenses, you’ve successfully become financially independent through real estate.
3) The Business Route
Starting your own business, especially one with low startup expenses, can be a great path to FIRE. But it’s also the riskiest and the least passive option of the three, at least at the start. 30% of new businesses fail during their first two years, 50% fail during their first five years and 66% fail during the first ten. Creating a successful business is tough work and comes with several risks. But becoming a successful entrepreneur can get you to FIRE faster than any other option. And once you get to the point where you have employees who can run the business and it generates enough profit to sustain your expenses, you can retire early (if you want).
4) A Blend of All Three
All three of the above paths have risks. The stock market could crash shortly before you retire. The real estate market might crash and your leverage might leave you high and dry. Your business can fail, as most do within their first few years. So how do you mitigate these risks? Diversification. Having multiple different passive income streams allows an overperformer to offset losses from an underperformer. Multiple income streams can also compound and get you to FIRE even faster.
Your path to FIRE can be customized to fit your life. If you have a lot of extra time, perhaps look into real estate investing or start a side hustle. If you have little to no time and make a great salary, consider investing in index funds. If you have the flexibility, patience and courage, try more than one of these options. Once you get to the point where your passive income matches your expenses, you’re no longer tied to that paycheck. You can keep working if you want, but the key word here is want. Once you reach FIRE, you can do what you want without relying on a paycheck.