How to put early retirement centre stage in how you spend and save

Until recent events in Ukraine, and the global economic uncertainty which has ensued, Michael Houghton was just three to four years away from retirement. What's so special about that you might ask? Well, Houghton is only 38.

Yes, while many people are resigning themselves to working as long as they have to due to the lack of a sufficient pension, Houghton is one of a growing number of people looking to cut back today to save for financial independence and the possibility of giving up work much earlier than the typical age of 65-66.

His epiphany came back in 2017. A freelance web developer, he lives with his wife and three boys in Limerick.

“We were barely scraping by. For years and years we did that, where we’d sit down at Christmas time and say: ‘My goodness, what do I have to show for a year’s work?’ I thought there’s got to be a way to feel like we’re actually working towards something.”

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Inspired by the Fire (financial independence, retire early) movement, which was starting to take off in the United States, Houghton thought it was something he could do. It wasn't an immediate conversion.

“Saving €500 at first seemed very difficult for us,” he recalls. However, rather than focus too much on expenses, and making harsh cost-cutting measures – always difficult with a family of five – he looked at his income.

“I wasn’t pushing myself hard enough as a contract developer to make enough,” he says, adding, “It’s a lot easier to earn more money than save.

“It just becomes a habit,” he says of Fire, but adds that it’s “kind of a double-edged sword, as you’re trying to fight a war on two fronts – reduce expenses and increase income”.

Fire movement

Houghton is not alone in his ambition. Fire is a global movement, aimed at encouraging people to live below their means while they’re working, so that they can save and invest towards early retirement, or part-time working. In essence, it’s about giving yourself the freedom to decide whether, and how much, you will need to work going forward.

Where once, early retirement was a possibility reserved only for millionaires or those in certain careers such as the Civil Service, Fire is trying to bring the concept to the masses.

Until recently, Houghton’s strategy was working well, buoyed by exuberant stock-market returns, but recent turbulence is giving him time to pause.

He structures half his investments within a pension fund, and half outside it, which will allow him to retire earlier than if it was all within a pension fund. An encashment date typically applies for pension funds, which can be as low as 50 years of age, but it depends on the pension structure invested in.

For Houghton, paying off the mortgage isn’t a priority; rather it’s about building an investment portfolio.

He lost money “taking chances on cryptocurrencies”, so these days he is focused on “taking the nice and easy path of investing in funds and equity within a pension”, although property is also in his portfolio.

While Houghton’s focus on boosting his income (his wife doesn’t work outside the home at present) means he puts in 12-hour days, he has flexibility around that. And working from home means he’s around for schoolwork with his children.

His approach is to save intensely for a period of four to five months – in February they saved an incredible €13,000 – and put it towards a goal. Their current focus is raising enough for a deposit for an investment property.

It’s about bringing a purpose to Houghton’s work and a purpose to how it is spent. “What am I going to spend my money on that will that bring me happiness?”

And it’s not all work and no spending. Back in 2019, Houghton took nine months off to spend time with their newborn baby.

“Whilst it didn’t help our financial future, it helped us enjoy time together,” he says. “We value our time over anything else.”

And it’s not all long-term saving. The family has an emergency fund in cash.

"Even though inflation is eating that alive, it gives us a great sense of security, knowing that even if I was to lose my main contract today, we could survive on that.".

It's not a life of penury: Houghton is from New Zealand and, with restrictions easing, a family trip is on the agenda, while the couple have also just renovated their kitchen, and Houghton is a member of a local golf club. It's more about bringing the concept of mindfulness to their spending.

Cognisant of rising fuel costs, for example, Houghton sat down and did the sums on how much their car was costing them. He decided it would be cheaper to get a newer, more fuel-efficient model, and so traded in his 2006 car for a 2013 diesel model. “Even with depreciation it will pay for itself in a number of years,” he says.

What’s your number?

It’s not just about saving and investing; you also need to work out a “Fire number” – or the amount of money you need to have saved in order to allow you to live work-free. Once you reach this number, the idea is that you can then live off your passive income built up through investments in equities, property, etc, much as you would do if you retired normally at the age of 65.

To calculate this number, you need to work out your annual expenses and then multiply that number by 25. So, let's say you calculate you need at least €25,000 a year to cover your household costs, including money for transport, the mortgage, etc. Multiply this by 25 and you get a goal of €625,000.

The idea then is that you draw down 4 per cent of this per year (which would be €25,000 in the above example). This 4 per cent should be adjusted for inflation, so in a year where inflation is at 3 per cent the withdrawal would be €26,250.

Much like mandatory drawdown in an approved retirement fund (ARF), the idea of the so-called "4 per cent rule" is that you can safely withdraw this amount each year, provided it is invested in a balanced portfolio of stocks and bonds which are growing, and you can be relatively secure that you won't run out of money.

Bear in mind, however, that advice on this is changing; US investment giant Vanguard recently warned that the 4 per cent rule is based on a 30-year retirement horizon. With Fire, on the other hand, many investors are looking to generate a big enough pot to keep them going over 40 or 50 years in retirement.

As a result, Vanguard warned that Fire investors may fall short of their retirement goals if they follow this approach; it recommends tailoring their approach to a 50-year time horizon, which would include minimising their costs and using “dynamic spending”.

This means that rather than drawing down a fixed amount each year – ie 4 per cent – investors should spend more when markets perform well and cut back when markets perform poorly. Such an approach, it says, should improve the chances that the portfolio will survive such a long retirement.

Once you have your goal, you can then work out your Fire age – the age at which you’re likely to reach the savings required to stop working.

In the above example, a 40-year-old person with savings thus far of €100,000 and annual expenses of €25,000 could expect to reach retirement at the age of 66.4, based on an annual return of 5 per cent and a drawdown of 4 per cent in retirement, with annual savings of €5,000 (so no early retirement for them).

Bumping up their annual savings to €10,000 a year and their retirement age comes down to 60.7. Savings of €20,000 a year mean a retirement age of 55.

You can work out what your Fire age might be at fireagecalc.com.

Bear in mind that these are estimates, and like any long-term investment strategy the future can be hard to predict.

Striking a balance

Undoubtedly, Fire is not for everyone. Its success or otherwise may ultimately depend on your personality.

“I’m naturally frugal,” says Houghton, “it’s really hard for me sometimes to justify spending money.”

While Houghton is very much focused on the end goal of retiring early, he is also mindful of the apparent contradiction in “working, working, working” just to try and retire early and then stop working.

In any case, he doesn’t expect to stop working completely, even when his finances allow for it. Instead he’ll probably work two days a week or so.

Even if Fire isn’t for you, there may be a message for us all in embracing “mindful spending”.

“I think everyone can decrease their expenses by about 20 per cent without causing any discomfort or unhappiness. Beyond that it gets a little more difficult and you can start to feel unhappy/miserable about it,” Houghton advises.

Want to learn more about Fire?

Fire Ireland holds a number of monthly meetings across the country, at which members can learn from each other.

Some of the meetings are still being held online, so check beforehand. In Dublin, the next meeting is on May 12th.