Category Archives: Financial Independence

zimmytws

When I first approached the world of finance, I had a completely different attitude than I do today. I was convinced that anything that was mathematically right coincided with the correct choice to make; therefore, simply doing calculations was enough to achieve any goal.

In particular, right from the start I was passionate about FIRE (Financial Independence, Retire Early). After all, being financially independent as soon as possible is all we aspire to when investing our money. In any case, I have noticed that in some cases the concept of FIRE is taken to extremes, and in this article I would like to discuss the problems that such a lifestyle can bring.

No one doubts that it is wise to save as a young person in order to have a nice nest egg as an adult, but it is not always the right financial choice for us.

FIRE refers to a lifestyle of reducing expenses and increasing investments to quickly achieve financial independence and the ability to retire at a young age. You can find many articles online that explain how to retire in your 40s or even 30s. There are some authors who promise you an early retirement simply by investing in a stock: my invitation is to be wary of those who promise you difficult goals with minimal effort. This is not the reality, otherwise we would all be rich.

FIRE's first problem concerns goal setting since there are no one-size-fits-all standards. What does it mean for us to be financially free? Getting around in a Ferrari at 40 or being able to cope with any unexpected expenses at 50? Much depends on the value we place on money.

The moment the goal is set, our life will revolve around it, so it is of crucial importance to do it judiciously. However, it is not easy for two reasons:

These two aspects generate considerable uncertainty and, more importantly, have a strong psychological impact over the years. When you are young, it is much easier to save and be positive, but the moment a mortgage and a family take over, unexpected expenses are the order of the day, which could jeopardize your constancy. As a result, you will be forced to reduce your investments and scale back your goals, which is not easy to accept.

In short, life is far from predictable, and in time, the goals you set in your 20s and 30s may turn into nothing more than a dream from when you were full of enthusiasm.

As mentioned earlier, the amount of money to aspire to in order to feel financially independent can vary greatly, depending both on the country of residence and the kind of life to be made once retired. For an American a good figure might be $3 million at age 50; for a poorer country $1 million would already be a lot. Be that as it may, in either case reaching this goal would involve a huge sacrifice for a person with an average income (obviously for those who are wealthy the problem does not exist). Specifically, in the case of the $3 million one would need to invest $18,237 each year and achieve an average return of 10%. And I am considering reinvested dividends.

Anticipating this by 10 years would imply an annual investment of $52,378. Basically, one would have to live with parents until the age of 40, have no family, hardly ever go out and have a good job as well. But is it really worth it?

If we were relying solely on the monetary aspect, it would be absolutely advisable to accumulate as much as possible in order to take full advantage of compound interest. Spending money or even receiving dividends (a tax disadvantageous solution) will postpone the time when you will be financially independent. However, people are not machines, and what makes sense mathematically is not always the right thing to do.

When it comes to investing, the most important thing is the psychological aspect in my opinion, since where and how much we decide to invest greatly affects the quality of our lives. Maintaining a balance and a certain serenity is what we should all aspire to, and I don't think it coincides with retiring at 40-45 years of age. You may have your $3 million at that age, but if you have completely sacrificed your best years you will probably have other problems to deal with.

Moreover, I doubt that a person with an average income can really maintain such a low standard of living for decades only to stop working at 40-45 years old. Saving as much as possible and investing for the very long term is sustainable only if the sums involved are minimal compared to the salary. Otherwise, the initial enthusiasm will gradually be replaced by a feeling of discouragement. After all, who guarantees that we will ever see the fruits of our investments? In 20-25 years, anything can happen.

The aspects that can really help you during your journey to financial freedom are only two: increase the money invested or improve the annual return.

Increasing the money invested obviously requires earning more money since saving too much can limit your lifestyle too much. In this case, it is useful to look at ourselves as a kind of investment, since the more knowledge we have, the more chances we will have to climb up the hierarchies work-wise. Spending thousands of dollars on our education instead of investing it in the S&P 500 may prove to be an even more profitable investment in the long run. So, in order to achieve an early retirement, it is also necessary to increase your knowledge: you may benefit both mentally and economically. Earning 20-30% more than the average can make a huge difference in reaching your early retirement.

The second aspect concerns the annual return, a component that can disrupt the final outcome. A small variation can lead to completely different results:

Of course, when we make an investment we hope that it will turn out better than expected and especially that it will beat the market. Anyway, we are not all Warren Buffett and that is often not the case. Investing in individual stocks rather than in a well-diversified ETF can prove to be no small mistake and may disrupt the timing of early retirement. In other words, taking big risks to get rich as soon as possible is a strategy I do not recommend for those who really care about their retirement. Wealth is a process and not an event.

For some people, getting 10% per year may not seem like much (average return of the S&P 500 over the past 30 years) but it is actually enough to create wealth: sometimes more than money, patience is lacking.

Early retirement is the dream that many pursue but few succeed in achieving. In my opinion, the reason why many fail depends mainly on the motivations that drive the individual to invest in the first place. The harsh truth is that financial markets will not make the average investor rich unless you are willing to be patient for decades. However, taking the FIRE concept to extremes can lead to a lifetime of regret, just as seeking high-yield investments can lead to substantial losses that will only make you poorer.

The right approach to operate in the financial markets is to take a long-term view, and to do this we need to look first at our psychological well-being: without it we will not be able to be consistent for decades. Assuming that the performance of the S&P 500 is similar to that of the past 30 years, it only takes a little to achieve a major accomplishment:

Since the average annual salary in the U.S. is $59,428, these seem like pretty affordable figures to me and not so high as to weigh on an individual too heavily. For those who save a little more, there would also be room for individual investments. Of course, even then you risk not getting the amount you hoped for, but at least you will not have sacrificed your whole life. Anyway, almost certainly even in the worst case scenario you will end up with a good nest egg. You won't be driving around in a Ferrari, but you can take a lot of satisfaction out of it.

Overall, I think the topic of early retirement is a dangerous fad because it generates false hopes in the average investor. Assuming there is someone who, thanks to his or her investments, can stop working before 50, he or she will not necessarily achieve the much-coveted happiness. Chasing that goal for the better part of a lifetime may have overshadowed many other aspects far more important than any amount of money. For those starting from scratch and earning average income must see the financial markets as a way to supplement their salary not to replace it and live off of it, otherwise they will most likely be disappointed. Accepting this harsh truth from a young age, I believe, is the only way to make the investment process satisfactory in the long run; the alternative is to tell ourselves a big lie that is not meant to last forever.

This article is aimed primarily at people of a young age; after all, they are the retirees of the future. In any case, I would greatly appreciate comments from someone with more experience. I think young people (including me of course) can learn a lot from those who have already faced this tortuous path.

Read the rest here:

Early Retirement Is Just A Big Lie - Seeking Alpha