Have you watched your investment portfolio tank recently?
There are dark clouds on the Financial Independence horizon at the moment – high inflation, food shortages, the energy crisis, supply chain issues, rising interest rates…
I find that times like these expose one of the FIRE community’s greatest flaws: our all-or-nothing attitude.
Let me explain.
How we usually think about Financial Independence
Time for a quick FI 101 refresher.
This is how we usually calculate our FIRE number using the 4% rule:
Annual spending x 25 = FIRE number
So if I want to spend $50,000 per year in retirement, my FIRE number is $1,250,000.
What this also means:
$1,249,999 = Not FI
$1,250,000 = FI
And this is where the problem lies.
FIRE and… Pregnancy Tests
When you take a pregnancy test, there are only two possible outcomes: Pregnant or not pregnant.
The traditional way to calculate our FI number looks at things the same way: We are either financially independent or not.
We all know that investing is nothing like this. It’s not black and white, all or nothing. Markets go up and down and sideways all the time.
In declining and volatile markets, this means that we could technically be FI one minute and not FI the next. You could be a millionaire when you meet a friend for lunch and lose tens of thousands of dollars by the time you order dessert. It’s normal and expected.
The lesson here is that if you make life decisions based on the FI / not FI response your spreadsheet spits out, things become stressful when markets slide.
Let’s have a look at an example to explore why this “pregnancy test” mentality doesn’t make sense.
Over The Moon And Back Down To Earth
Meet Emma. Emma is 45 and has been investing in *a popular investment product I’m not allowed to talk about anymore – thanks ASIC* for over 10 years.
Emma’s FIRE number is $1,250,000. She can’t wait to quit the corporate job she hates. Emma checks her portfolio performance daily.
One day in December 2021, she logs into her portfolio tracker account and can’t believe it: she has reached the finish line (the equivalent of a positive pregnancy test)!
Emma is over the moon. She immediately starts making plans to quit her job in the near future. She can’t wait to finally live the good life. She doesn’t know what she wants to do once she finally doesn’t have to show up at the office 5 days a week, but she is sure she’ll figure it out.
She checks her portfolio again in early January 2022, and things are looking even better. Her net worth has passed the $1.3 Million mark.
But then something terrible happens: The share market starts falling. The news headlines are dominated by stories about rising inflation, skyrocketing interest rates and a looming recession. Over the next six months, Emma’s portfolio value continues to drop. By the end of June 2022, it is worth a meagre $1,085,351 – not even close to Emma’s FI number.
The Big Flaw
Emma went from financially independent to not even close to her magic number in just six short months.
Sure, the trinity study tells us that in theory, Emma’s nest egg should still survive over the next 30 or so years.
However, this theoretical knowledge will likely do nothing to tame Emma’s emotions and panic in this situation.
I challenge you to find one person in real life whose nest egg dropped significantly shortly after reaching FI and who just went on as if nothing happened. We are emotional beings, not robots.
The reality is that Emma will probably be a little freaked out. There is almost no chance that she would actually start making annual withdrawals from her nest egg under these circumstances.
Chances are that she would keep her job and continue saving until she gets back to or close to her FI number.
This is the big flaw in the FIRE concept: the idea that there is a definite finish line. That once we see the second line on the pregnancy test, we can finally relax and enjoy life.
It doesn’t work like that.
All we are doing by solely relying on our nest egg to provide the freedom we want is to shift from being financially and mentally dependent on a job to being dependent on the financial markets.
The Finish Line Illusion
The closer I get to my own FIRE finish line that I set for myself, the more I realise how irrelevant our “magic number” is.
Don’t get me wrong, tracking our net worth is important and making progress charts is motivating and fun. I enjoy pulling all our numbers together for our quarterly semi-retirement updates. But charts and spreadsheets just don’t tell the whole story.
The 4% rule is a great tool, but these days I see it more as a rule of thumb and a compass. It’s just one part of a good life plan in my opinion.
Many hardcore FIRE folks end up over-saving by either dropping their withdrawal rate to something like 3% and/or saving 35-40x their annual spending “just to be on the safe side”. This is also where the roots of “one more year syndrome” lie.
These “safety measures” might increase the likelihood of success in the financial sense. But making our plan more bulletproof usually also means that we’ll hold off on living our best life for longer.
By saving more, we simply move the goalpost. We still follow the pregnancy test mentality. We just make it harder to get a positive result.
It’s a fear-based approach.
I personally think there is a much more effective AND enjoyable way to ride out storms like the current one. And that is to simply focus on building a great life based on our values. A life that prioritises connection, health, and personal growth that also includes some meaningful work.
A mix of passive investment income and active income from work I enjoy and am passionate about makes me feel financially bulletproof without wasting years of my life saving an absurd amount of money I may never need.
See The Market Correction as an Opportunity
This current market downturn is a fantastic opportunity to assess our relationship with “the finish line” and our “magic number”.
Do you suffer from all-or-nothing syndrome when it comes to your financial goals? Are you delaying doing the things you want to do with your life in the name of FIRE? Are you watching your investment returns like a hawk, obsessing over paper losses and potential buying opportunities? Are you re-thinking your plans and building in “safety buffers”?
If so this might be your chance to work on your mindset. You can use it to move toward living in the “green zone” where you get to enjoy life no matter what the markets and your spreadsheet are doing. That’s the real wealth Financial Independence can create.
Remember, life doesn’t take place in a spreadsheet. A drop in the market should not have a significant impact on our life decisions.
What To Do In Scary Times
The concept that we are either FI or not FI is too simplistic. And over-saving just to satisfy our scarcity mindset and fear of losing it all is not the solution either.
Instead, we should focus on creating the kind of life that won’t be impacted if your portfolio drops by 20%, 30% or even 50%.
Here are some ideas to get you started:
- Realise that the “pregnancy test” mentality is a fallacy when it comes to FIRE and investing.
- Develop an abundance mindset and stop living in fear of not having enough.
- Start living in the “green zone” of the financial freedom spectrum.
- Create a balanced life with some enjoyable part-time work that you wouldn’t give up even if you didn’t need the income.
- Consider alternative FI approaches like semi-retirement.
- Keep learning and developing new skills.
- Focus on your health and relationships instead of your spreadsheet.
Implementing some of these ideas will make your net worth number increasingly irrelevant. Not because your net worth won’t drop, but because it doesn’t impact your life choices. This is how you become immune to market downturns like the one we are currently experiencing.
So, what is your relationship with the “finish line”? Do you treat your portfolio like a pregnancy test?