What is the FIRE formula, and can you really use it to retire in your forties?

Financial Independence and Retiring Early – these four words represent the financial goals of most long-term savers. In fact, the ‘FIRE’ formula has won a cult-like following among 40-somethings in the US, who believe they have cracked the formula to financial freedom. And now, the FIRE movement is coming to the UK.

But what does it actually involve?

The ‘FIRE’ formula was coined by a Canadian blogger called Mr Money Mustache, who retired in his early 30s after more than a decade of frugal living and financial discipline. He has made it his mission to help others achieve monetary freedom, with the end goal being financial independence and early retirement.

FIRE enthusiasts see financial independence and early retirement as two sides of the same coin – and in a way, they’re right. Total financial independence means that you are not reliant on anyone for your income – including your employer. Therefore it follows that once you have achieved financial independence, you should be able to quit your job without reducing your quality of life.

According to FIRE devotees, you can only attain financial independence when your savings are at least 25 times the value of your annual expenses. This means that if your average annual expenses (including luxuries and holidays) add up to £20,000, you will not be financially independent until you have savings to the value of £500,000.

The rules of the FIRE formula

The FiRE formula. Can you retire early?

In theory, it is possible to use the FIRE formula to retire by the age of 40, but only if you are prepared to work hard, save even harder, and avoid all debt.

Here are some of the core rules you need to follow if you are using the FIRE formula to retire early.

• Rule 1. Live on half your salary – maximum.

This is the core tenant of the FIRE formula. No matter how much you earn, no matter what profession you are in, you should always be saving at least 50 per cent of your annual salary, after tax. Mr Money Mustache has estimated that by saving half your salary, you should be able to retire within 17 years. So if you start work at 22, you would be ready to retire at 39.

However, this is no easy task for the average earner. In order to live off 50 per cent of your salary, you either need to earn a LOT of money, or you need to make some cutbacks. That may mean moving to a cheaper location, scaling back your social life, or cooking every meal from scratch every single day. And these cutbacks are not a temporary solution. The more you can reduce your annual cost of living, the less you will have to save for retirement.

If you really can’t do without your morning latte and winter sun holiday, you may need to make peace with the fact that you won’t be able to retire at 40.

• Rule 2. Never ever go into debt

Debt is expensive, and it comes in many different forms. From credit cards, to car payments, to overdraft charges – any time you take on a new piece of debt, you can expect to pay interest rates that can easily drift into the double digits. According to FIRE devotees, if you have to buy something on credit, you can’t afford it.

Any unavoidable debt (e.g. your mortgage or your student loans) should be prioritised over every other expense, so that you can pay them off as quickly as possible. But beyond that, it is vital that you stay debt free so that you can focus on your savings instead.

• Rule 3. Save conservatively

When you are saving for early retirement, you can’t afford to take any unnecessary investment risks which could potentially set you back by a few years. Instead, keep the majority of your money in conservative savings options such as long-term bonds and FSCS-backed bank accounts.

Mr Money Mustache has stated in the past that he also invests in rental properties and in “very boring conservative Vanguard index funds”. By diversifying your savings, you can reduce the risk of any big losses, and you may even increase your overall rate of interest.

• Rule 4. Always aim to match (or beat) the rate of inflation

This rule could pose a challenge for UK savers, as only a handful of savings accounts currently beat the rate of inflation (2.4 per cent in September 2018). However, if your money is not increasing in line with the cost of living, you will essentially be losing value on your money as you try to save.

The Bank of England has set a target of two per cent for inflation, although the consumer price index (CPI) has been above two per cent for several years now. If you are locking your money away in a bond or a fixed term savings account, do not even consider an account which offers less than two per cent per annum.

• Rule 5. Use your ISA allowance

To really accelerate your FIRE savings, make full use of your annual ISA allowance. This is an advantage that your US counterparts don’t have, and it can shave years off your savings plan.

Each UK taxpayer can shield up to £20,000 in an ISA wrapper every year, and that allowance resets every 12 months. That means that you can transfer an existing ISA balance into a new account every April, gradually building up an ever-increasing pool of cash.

Kathryn Gaw

Kathryn Gaw is a financial journalist based in Belfast, Northern Ireland. She has been writing about personal finance and investment trends for more than a decade, and her work has been featured in the Financial Times, City A.M., the Press Association, and The Irish Independent, among many other publications.