The “Financial Independence, Retire Early” (FIRE) movement has taken off in the US and is making strong inroads in Australia. Driven by Millennials seeking financial control and flexibility, its US philosophy of spend less, save more and invest is embedded in the following prevailing lifestyle thematics: strict budgeting and frugal living, sometimes to the point of a ‘minimalist’ lifestyle; an aversion to debt; working extra gig-economy jobs to boost income early in life; relying on low-cost growth investments such as ETFs to both build capital and draw from in (early) retirement.
Perhaps this movement is a response to the perception of Millennials as spendthrift, “live for the moment”, smashed avocado consumers, at least in Australia.
In the US, there are almost half a million followers of a Reddit page dedicated to FIRE. The site has an Australian page and several local blogs have jumped onto the theme.
You can’t help but admire many elements of this movement. A rebellion against the unbridled materialism of the Baby Boomer generation (and against the willingness to enslave oneself to debt to achieve it) is long overdue. Arguably, it is also a response to the increasing need for flexibility, given the challenges of the gig economy. It’s characterised by a desire to achieve true financial independence early, to avoid reliance on government handouts, to be involved in work and activities one enjoys or simply to spend more time with family and friends – what’s not to like?
THEY RISK DISAPPOINTMENT
While FIRE might be nothing new, the investment strategies this set uses have become overly dependent on a narrow worldview formed by recent market and economic experience. In particular, they risk disappointment, given their high expectations of future returns and their downplaying of the risks of some of the investment strategies employed.
FIRE followers seem to believe they have found a foolproof investment strategy – to build, and then finance, an early retirement via a long-only, buy-the-dip approach, either to direct investments in technology stocks or to exchange-traded/passive funds that are heavily dominated by such stocks.
While it is true that broad-based passive funds will probably outperform the average active fund over the long term, simply from the mathematical benefit of lower cost, this doesn’t mean they are certain to be a high-performing investment strategy or even to make money.
Indeed, in an extended, secular bear market, they are almost guaranteed to lose money, which is not the case for some active funds. Also, those betting heavily on technology stocks only, and thinking they are diversified, could be in for a real day of reckoning if months such as October 2018 become more common. At certain stages of the market cycle, when valuations are high and perceptions of downside risk are low, the pursuit of passive, long-only strategies looks dangerously like backward looking performance chasing with significantly increased probability of poor outcomes.
THE LOCAL VERSION
While there seem to be some differences between Australia’s FIRE movements and those in the US, one commonality is a near unquestioning faith in passive investment as the primary strategy.
Those in the Australian FIRE movement seem to have a greater reliance on property investment as a key to building wealth than their US counterparts. No doubt many local investors’ strategy of using minimal equity to leverage into multiple investment properties in a rising market has worked well until recently.
Another interesting aspect of the local FIRE forums is a focus on lower-cost listed investment companies as an appropriate vehicle to complement ETFs and index funds. This is partly driven by the Australian quest for fully franked dividends, which also encourages some to focus on direct, high-yielding shares.
Often, the FIRE strategy is simplistic and unrealistic about the money needed to retire early in comfort. There seems to be excessive reliance on a standard rule that one can withdraw 4 per cent of the portfolio each year and growth and income will reliably replace this. What about in a deep or extended bear market? This approach has flaws even in a well-diversified portfolio for older investors. In the FIRE set’s equities and technology-focused portfolios for much younger investors, it’s almost destined for failure. A 50 per cent drawdown in a growth portfolio means 4 per cent provides half the money it previously did. Pull out 8 per cent to get the same dollar amount and the destructive powers of sequencing risk become clearly apparent.
And what about inflation? There seems to be enormous complacency about the risks of periods of higher inflation or even about the destructive value of low rates of inflation over extended periods.
What about the risk that market turbulence affects investors emotionally such that they might not even stick with the strategy and possibly unwind it at the worst possible time – at the depths of a bear market?
These issues are exactly the ones that quality financial planners spend much time on with their clients but they aren’t prominent in most of the FIRE discussion I have seen.
In my experience, it is the behaviour of investment markets that redefines the attitude towards finance not the other way around. New generations may change structural aspects of how they interact with investment markets, especially as technology develops, but not the inherent nature, opportunities and risks of those markets.
Certainly, the FIRE philosophy is a long way from the greedy arrogance of the 1990s dotcom day traders who expected to get rich overnight. Indeed, to the extent that using passive investing and ETFs is integral to the FIRE approach, there is a degree of humility in accepting how hard beating the market can be.
Having said that, patience may still be lacking; that’s unsurprising, given the point is to accelerate wealth building. As Leibowitz says: “They will no longer settle for slow and steady progress to build a comfortable nest egg. They’re motivated and self-educating, finding new tools to create wealth and reach their goals.”
PAINFUL (AND VALUABLE) LESSONS
The implication from some of these forums, partly because of the heavy passive reliance, is that it’s all easy and requires as little as a one-day course or reading a couple of blogs. There seems to be little self-education on how investors should manage their own behavioural and emotional biases through market cycles.
Education about investments is a long process starting with unlearning some of the false material taught in economics and finance courses (perhaps this has improved), reading books about financial market history and great investors, actually making live mistakes over a number of years, experiencing a range of different market environments, and perhaps being helped along by experienced investors or mentors. This is the case even if one does no stock picking, as one is still responsible for asset, structure and manager selection decisions if using ETFs, LICs and funds.
The basic principles of the FIRE approach are valuable building blocks for a robust approach to personal finance. Yet these principles risk becoming hostage to backwards-looking portfolios that have worked well in the recent economic and investment environment but may struggle to continue to do so, given high market valuations and changing fundamentals. The generation that has emerged in the decade since the GFC seems to have developed overly optimistic assumptions of what returns markets will deliver and the pattern in which they will deliver them. This is no surprise, given equity and property returns over that decade.