Key Tenets and Framework of F.I.R.E
Let me use a basic framework, which includes the key tenets of F.I.R.E. I am structuring the discussion of F.I.R.E here into three parts, namely:
1. The Plan – Know What You Want
2. Income – Know What You Have
3. Expenses – Know What You Need
Savings, central to F.I.R.E, is simply income deducting expenses.
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To reach the objective at the top, we start right at the bottom, which is the quintessential of F.I.R.E. We need a Plan and most of all, we need it early. If you are thinking of attaining financial independence at age 45, but you are now 42 and have not previously planned, it will be very onerous.
The Plan needs to include, among other things:
1. The target age for financial independence attainment.
With F.I.R.E, the target would usually be lower than the ‘normal’ retirement age as I discussed earlier.
2. Savings, broken down into:
A. The level of expenses required, post-financial independence attainment, including the effect of inflation. It does help immensely to have a baseline expense, which is the current level of expense the person is running on. Without this piece of information, there will be too much guesswork involved, which can be fraught with misjudgement.
B. Income and investment assumptions, including targeted income growth and investment returns.
The Plan provides the overarching guidance and the key is that it has to be realistic; it is pointless putting out a Plan where one has no chance of making. For example, if one assumes an income growth of 15% per annum, it is high unlikely the Plan will work. By the same token, should someone assume 20% annual returns on equity investment, a dose of realism is lacking there.
With the Plan formulated, the next thing item on the menu is the execution, which is the implementation of the Plan and translation into specific income and expense actions, on a yearly basis recommended.
On this side of the F.I.R.E equation, some things to consider are:
1. The investment strategy
The strategy has to be in line with the Plan. For example, if the Plan assumes a target return of 7%, it does not make sense to invest entire resources in fixed deposits or other low-yielding products.
2. The work/business income side
Again, this needs to be aligned to the Plan. If the Plan calls for an income growth of only 3%, the usual corporate yearly salary increment should suffice. On the other hand, should the Plan assume a more aggressive income growth, we will need to accelerate our career and ensure there is progression (with accompanying salary increase), to make it work.
3. It is very likely the income for the Plan, at the stage when you are no longer receiving a salary, is modelled on a straight-line.
Dividends and investment returns, however, seldom behave in that manner. Do consider annuity solutions to inject some linearity so that your non-work income resembles the Plan.
The crux of this part of F.I.R.E is mainly tracking of expenses, and managing the expense budget which is consistent with the overall Plan. What you cannot measure, you cannot manage. It is imperative to have a good handle of where we are in terms of actual spending, versus where we should be. There are a few things to note:
1. Expenses can make or break any Plan.
A well-thought Plan should accommodate an expense level that is realistic, sustainable and thus, possible to live to. Tracking expenses regularly (and I would recommend at least once a quarter) against the Plan will provide us with a good idea if we are on course. If off-course, we should consider addressing it sooner rather than later, lest things get out of hand and we run out of time.
2. Having an expense budget to live within, does not mean we live extremely frugally to the extent that life ceases to be enjoyable.
On the contrary, it enables us to have an indulgence without the guilt. For example, if you have budgeted for a branded handbag, you should be able to go out and shop for it with the knowledge it will not cause you to be out-of-budget. By the same token, should you splurge on something which is not in the expense budget, you will have to make-do with spending less on something else which has been budgeted for. Life is all about trade-offs. You win some, you lose some.
3. Consider carefully, managing your risks via insurance.
There are some non-negotiables here. Hospitalisation and critical illness insurance are two here. Imagine if you do not have a hospitalisation plan, you could face a hefty bill should health issues occur, which will derail your Plan. Paying premiums, unfortunately, is a necessary evil here. It provides predictability. It pre-empts nasty surprises. You take the element of uncertainty out.
Just as we do not include winning a lottery on the income side, we do not want to be saddled with a big expense hit due to issues beyond our control. With a good plan, we do not gamble. For F.I.R.E, the timeline is compressed and there is little runaway to leverage in the event of an unplanned large expense.