Cash Flow is King, Especially When it Comes to FIRE

At some point, you may have heard of the Financial Independence Retire Early (FIRE) Movement.

Broadly speaking, the goal of FIRE is to save as much money as possible in order to retire as early as possible. However, even when accounting for the compounding of interest to work its magic, achieving FIRE can still take a long time.

Let’s look at a quick and dirty example using some real-world data.

According to WorldPopulationReview.com, the average household in the United States spends $61,334 a year on expenses. Assuming a 4% safe withdrawal rate, the average American household would require an investment portfolio totaling $1,533,350.

If the average household can save $5,000 per year and invest it in a stock market index fund with a 10% annual return, it would take them approximately 36.3 years to achieve FIRE.

But how can we speed that timeline up and FIRE quicker?

One popular option is to reduce expenses and spend less money overall.

However, with recent high inflation, this can be challenging. It's essential to strike a balance between reducing unnecessary spending to improve financial health and maintaining a good quality of life. While cutting expenses that don't contribute to our happiness is wise, it's also crucial to continue spending on things that genuinely make us happy.

Option number two is choosing investments that consistently outperform the stock market. Nevertheless, due to potential overconfidence bias and the fact that 'nearly 90% of actively managed investment funds failed to beat the market,' this is a conceivable but not realistic long-term strategy to depend on.

Finally, there's the 'just make more money and save more money' option. However, this is easier said than done. Using data from the Bureau of Labor Statistics and the Federal Reserve, here's the average U.S. hourly wage growth and average savings per hour adjusted for inflation from 1964 to 2020:

As you can see, the average hourly wage in the United States has remained largely unchanged since 1964. This tells us is that average wage growth in the United States has been virtually non-existent due to inflation.

So, if lowering expenses, beating the market, and increasing income are not possible, what else can we do?

Well, there's a neat math hack we can leverage to reduce the time to FIRE, and that's focusing on recurring cash flow instead of trying to increase our portfolio size.

Let me explain.

Using the 4% safe withdrawal rate mentioned earlier, every $1 earned outside of our portfolio is equivalent to reducing our retirement portfolio by $25. This is based on the same math as the 4% rule developed in the Trinity study.

The idea is that with a recurring income capable of covering our recurring expenses, we would need a smaller retirement portfolio to cover the remaining living expenses.

For example, let's imagine taking on a flexible, enjoyable part-time job during retirement that earns us $5,000 annually. This means we wouldn't need to save an extra $125,000 in our portfolio, equivalent to 25 years of straight savings.

Now, let's visualize how different levels of recurring cash flow can affect the path to early retirement.

Notice that the required retirement portfolio decreases significantly with even small increases in recurring cash flow. Whether it's income from a part-time job or rental income from real estate investments, how we generate this cash flow ultimately depends on our goals and lifestyle preferences.

Regardless of the source of immediate income, the end result is shaving years off the journey to early retirement. Because, in the end, achieving FIRE is simply a numbers game. There are various paths to 'win,' but concentrating on a strategy that maximizes a reliable and recurring cash flow stream is certainly a tactic that can help us 'win' sooner.

Disclaimer: Nothing in this article should ever be considered advice, research or an invitation to buy or sell securities. I am not a financial advisor.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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