Financial Freedom or Financial Trap? Why the FIRE Movement Is Dangerous for Most

Paul Winkler: Welcome. This is “The Investor Coaching Show.” I’m Paul Winkler, along with Mr. Jim Wood hanging out here in the studio with me today.

Why Don’t People Feel Prepared for Retirement?

We’re going to be talking money, investing, and financial planning. And the topics of the week will come up, and the topics that have been in the news will come up, of course, because that’s what we do around here.

We talk about what’s happening in the financial world and give you some things that you probably ought to be staying away from. That’s one of the things that I’m really, really keen on.

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Sometimes it’s not just what should I do; it’s what shouldn’t I do that matters. 

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That is pretty important because a lot of people do things that aren’t necessarily so great with their finances. I’ve just seen it. What’s the evidence?

And Jim, I wasn’t planning on going here, but this is something that comes to mind all the time because you think we’ve got a huge financial industry, huge companies, massive companies that spend tons of time advertising, tons of money advertising about how to prepare for retirement. And, yet, we see the statistics. Well over 50% of people — and I’ve seen numbers that go up to 70, 80% of people and sometimes even higher — don’t feel prepared for retirement.

And you go, “Well, wait a minute, you got this huge industry that’s supposed to be taking care of this. Why are people not feeling prepared?”

And I’m telling you it’s because there is a difference between this industry, the financial industry, and just about everything else out there. You look at everything else out there, you look at cars, you look at dentists, you look at, let’s say, home repair, you look at whatever, you’re typically looking at judging something based on “What are my short-term results? How did things go?”

Let’s say, “Did my dental work give me problems?” And if so, my dentist didn’t do such a great job.

If I have a car that breaks down all the time, every time I pull out and go anywhere, then my car repair person didn’t do such a great job. Or, let’s say the manufacturer of the car didn’t do such a great job if it’s a new car, and it’s a lemon. So, if that’s the case, then we can easily tell that there’s a problem here and we have somebody that’s providing a service that’s not doing such a good job.

With financial, the problem is that markets go up, and they go down. And you won’t know many times. This is a frustration; you won’t know, and I think this is what causes people to hesitate getting advice on finances.

Anyway, this is what the research shows. I’m just going to say that.

Hesitancy Around Retirement Preparation

I’ve actually done some research on this, and this is one of the reasons that people give for being really hesitant to save money and prepare for retirement and do a lot of preparation, because what they find or what they believe and know to be true is they may not know for 10 or 15 years whether they’ve made a good decision or not. That’s a long time to wait to know whether you’ve done something right or not.

Jim Wood: Yeah. And it can be a lot longer than that. And certainly, from a lot of the research on investing, the data isn’t really considered good until you have multiple decades. Sometimes it was like, what is it, the 60, 70 years?

PW: It’s 60, 70 years for GenePharma. Was your investment manager, was it skills that caused them to get the results they did, or was it luck?

JW: Right. Yeah. Stuff like that.

PW: Yeah, for sure.

JW: People just, “Well, how do I know? How do I judge this and everything?”

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The problem on the other side of that is everybody’s promising you immediate gratification. 

 

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“Buy this fund and you’re going to make more. We’re the smartest ones, we’re going to buy all the companies.”

 

PW: Oh, yeah.

JW: And so you go with that, or people do. And then they find out that the company is lagging the market or made some bad bets and things like that. And so you get turned around.

PW: “But it’s going to come back.”

JW: Yeah.

PW: “But it’s going to come back.” So, after something has done poorly, it’s like, “I’m going to wait for it. It’ll come back.”

Or, if it’s done well, “I want to stay in it because it’s done well, and I’ve won.” And that’s why I often tell people that, let’s say if you’re into day trading or into some kind of a kind of more of a gambling type of an approach to investing, probably the best thing that you could ever do is fail early and get it out of your system that you have this great skill.

JW: Yeah. I mean, it’s just based on nothing other than current events. And that’s the problem.

People, emotions are driven by that, and so they make decisions based on those emotions. And then the results, they wonder why the results are so erratic.

PW: Yeah, for sure.

JW: And that’s why it’s really important to have that process that takes you through things to where you’re not worrying about, “Okay, the gas prices are up or down this week. What’s going on with the war? What’s the Fed going to do? Who’s going to be elected?”

Because those types of things, they’re going to beat you to death with on the media and the financial media, as well.

PW: Oh, got you.

JW: It’s not just the opinion channels. And they’re trying to get you to listen to them. They’re trying to get you as a viewer for advertising dollars.

PW: Eyeballs glued to the screen.

JW: And, of course, their advertisers want to get you to do whatever they’re trying to sell you.

PW: It’s got to be short-term stuff.

Financial Independence, Retire Early

PW: So, what leads me to this is what I was reading a little bit about the FIRE movement this morning. So, Financial Independence …

JW: … Retire Early.

PW: Retire Early, right? It’s the FIRE movement. It’s an acronym.

And there was an article, it was in the Business Insider. “A millennial reached financial independence by 25” — age 25 — “using the ‘fast version’ of FIRE and focusing on cash flow” was the article. This caught my attention, because this would be an opportunity to share something that I’ve thought about regarding this movement, so to speak, and things that people don’t necessarily think about.

But it was talking about this guy, it says when he “started pursuing financial independence, his plan looked a lot like the traditional FIRE playbook: save and invest aggressively, build up a large stock-market portfolio, and eventually live off a small percentage of that nest egg each year.”

And there was a book called “Retire by 30.” And there was a host, this guy that’s a host of “The FI show.” But, basically, he used what’s called the 4% rule, and I’ve talked about that, and Jim and I have talked about this before.

If you take your investment portfolio and say, “Well, how much money do I have? What is 4% of that amount?”

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So if I’ve got $1 million, that’s $40,000. So if I build up $1 million, I can take a $40,000 income and inflation-adjust it, so to speak. 

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More about that in a second. But it said that his initial target was to do that.

So he was basically going to try to build up $1 million, and $40,000 was his income. And what happened is he started his first corporate job in real estate — and real estate lending is what he was doing — and built a spreadsheet showing that if he kept living in his side hustle income and saved his full salary — so he had a side hustle and he’s doing this main job earning a much higher income — he figured if he could just live off of the side hustle and then just save everything he made from his main job that that he could get there, and he could retire, and that would be it.

The Nest Egg Method

PW: It said that “there are two main paths to financial independence.” He said, here is his: “The first is what he calls the ‘nest egg method,’ [which is] the traditional FIRE path built around large investment portfolio.”

It said the appeal is in its simplicity. All you have to do is take what you want to spend each year, multiply that by 25.

So if you take 40,000, you multiply that by 25, it’s another way of getting at that number. That comes to a million, and that tells you how much you need to save or put aside.

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Now, I say you just buy low-cost index funds, and we’ve talked about indexing. The good part about indexing is that it can be low cost.

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The investment strategy is don’t stock pick, don’t market time, which we’re pretty big advocates of. But the issue that you run into is that you’re overweighting big companies, and you can go 10, 20-year periods with no return in large companies.

Now we haven’t had that recently. Well, I say we haven’t had it recently. We did from 2000 to 2012.

But you’ll have small-cap indexes, and then they underperform their area of the market, small companies, because they overweight the big small companies. And then the value indexes they overweight the bigger growth-y value companies, which hurts the returns, as well.

So in here he’s basically saying, “Just do that, and you’re done.” It could be pretty myopic because of those issues, those hidden expenses. But it is better than the active stock picking, market timing that we often see in the investing world.

Now, it says, “The trade-off is time and, potentially, lifestyle. Even with a high savings rate, building a seven-figure portfolio can take years or decades. For people trying to speed up that timeline, the traditional path can require years of aggressive saving, low spending, and delayed gratification.”

The Cash-Flow Method

PW: The second path is his path. He says it’s “the cash-flow method. Rather than building a portfolio large enough to draw from, the goal is to create enough monthly income from assets to cover living expenses. That cash flow can come from rental properties, businesses, digital products.”

So, in this particular case, you wouldn’t necessarily be retired, by the sound of it.

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If you’re building up a real estate portfolio, you’ve just changed your employment from whatever you do for a living to real estate as your job.

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JW: That seems to be a theme, and when I’ve seen different writings on the whole FIRE movement, it is always, you mentioned side hustle, and it seems the people that are writing about this and telling people how to do it, well, they all make money by writing about it.

PW: That’s their side hustle, huh?

JW: Yeah. So can everybody be a blogger about the FIRE system?

PW: That’s funny. Yeah.

JW: So, of course not. So, I guess there’s lots of possible side hustles.

But that’s the thing with this. It’s not just, “Okay, I got to save a bunch of money, and then I’m going to retire for 60 years,” or whatever it is.

It’s, “I’m going to maybe not have to go to a job.” But almost everything that I’ve ever read has something to do with, you still have to get an income from somewhere.

PW: Well, Jim, I think that I would be the poster child for the FIRE movement in this particular case if this is the definition of it. Because I was working in an investment firm.

We were doing mainly health insurance and employee benefits and Section 105 plans, a lot of stuff that probably a lot of you have never even heard of, doing property and casualty insurance. We were doing a lot of group type of plans, benefits and things like that.

You know what my side hustle was? It was studying the academic investing research and implementing it. That was my side hustle.

JW: Yeah, there you go.

PW: So maybe I’m the poster child for this.

JW: Well, if this financial services thing doesn’t work out for you …

PW: Yeah, I think it worked out okay.

JW: You have the drumming to fall back on.

PW: There you go. That’s my side hustle now. That’s my hobby now.

What’s Wrong With the FIRE Movement?

PW: So, yeah, if we look at this and we say, okay, so that’s a definition of it. But the traditional FIRE movement, that’s really what I want to spend some time on.

I was thinking a lot about this this morning: What is it about the FIRE movement that I object to, so to speak? And I think there are several different things.

Number one, this was based on, remember it was based on the 4% rule. So, if I want to get $40,000 of income, I need to have, let’s say, $1 million saved.

And that’s where the 4% came from the Bengen research. Now the thing about the Bengen research on how much income can you take from a portfolio and how long can it last and you still have a cost of living increase, it was really only designed for a 30-year retirement.

JW: That’s exactly what I was waiting to get out. Before you said it.

PW: I stole your thunder.

JW: Because you see that it just, the portfolios really start to crash around 25, 30 years doing that 4%.

PW: Some of them. Not all, but some of them certainly can.

JW: Depending on sequence of returns and all that.

PW: Yeah, that’s exactly right.

JW: But certainly, the risk gets higher and higher the longer you draw that out, and retiring at age 40 is much, much different in terms of your chances of success than doing it at 65.

PW: Yeah. And imagine yourself if you retire at 35, age 40 or something like that, and you’re not dealing with a 30-year retirement, you’re dealing with 50, 60, 70 years.

And the reality of it, it’s just like you said, the sequence of returns risk issue. What that is in English is that let’s say if markets go down, you have to sell more assets to get your level of income that you need.

And then by the time markets recover, well, you’re out of money, and that’s the problem you run into with taking an income, if the sequence of returns or the order of returns is not in your favor, where you have really good returns upfront and bad returns later. Now that’s where you can have a situation where an investment portfolio lasts not just 30 years, but 40, 50, 60, 70 years, or on into infinity pretty much, if you have good sequence of returns, if it looks good.

Now, what has happened is a lot of FIRE candidates have moved to a little bit more of a conservative as a result of that going to 3 to 3.5% distribution rate, and they have a lot more flexible spending rules.

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But then you’re looking at a much longer period of time to get the number of the dollar figure up there to be able to get the income that you need.

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And you might have to have a side income, and that’s one of the things that they’ve been going to, and that’s kind of where this guy is going. He’s going to have a side income.

Human Capital as an Asset

PW: Now the other thing is this: You can look at human capital as being an asset.

So, what that means is if you look at getting out, and you’re saving up and you’re saving up and saving up and you have everything saved, and you get to age 35, age 40, and you feel like you’re going to retire, then all of a sudden you’re retired and several years goes by and your portfolio starts to go down in value because the sequence of risk or sequence of returns risk is not in your favor. Now you can have a situation with that major market downturn, or unexpected health expenses, or divorce, or family obligations, or inflation that is beyond what you expected.

Now you are actually having to go back to work. And you’re thinking, “Well, I’ll just go back to work.” Well, yeah, good luck with that.

Because your skills depreciate, and your professional networks — you don’t have professional networks anymore. You don’t have the traditional things that we need in order to make a decent income. Technology changes.

Can you imagine being somebody that was in the workforce 30 years ago, Jim, and then all of a sudden you’re in the workforce, and then you go out and you retire, and you come back and you see the technology that we’re dealing with today, with networks, with software programs, with cloud computing and all of that?

You’d be lost as last year’s Easter egg trying to get back into that workforce. Yeah, go ahead.

JW: No, I was just thinking on the whole thing, too, with the FIRE movement, the idea that, okay, “I’m going to scrimp and save and get this pool of assets that then is going to last me for the rest of my life.” But that means going through likely the best health of your life, and you’re going to miss out.

“I’m going to give up all this stuff now, so I’m going to miss out on all these experiences now because I’m going to save every nickel, live very frugally so I can try to do this.” And so you end up just missing out on all these experiences and life along the way. And then you’re not, and nobody’s ever, guaranteed anything, either.

PW: Yeah.

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It’s like the guy with the barns in the Bible, right? The guy builds up all the money in the barn, and then his life, all of a sudden, is over.

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JW: Yeah.

PW: So, yeah, he’s warned about that. Yeah, that’s a really good example.

Underestimating How Much You’ll Change

PW: The other thing is — I was thinking about this — people underestimate how much they’ll change. Their taste and their desires will change. At age 30, it’s easy to try to imagine what you’re going to want at age 60. But usually what ends up happening is you’re wrong.

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Your tastes are totally different than what you thought you’d want life to look like. You may end up discovering new hobbies that may be expensive. 

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I always joke around about flying cars. At that point when they’ve got one, and you can go from A to B, and the FAA says, “Yep, you can do that. You can fly over roadways and all that stuff.” And if you can’t afford that because you’re not working anymore, you can’t afford the technology, then you’re kind of left behind at that particular point.

JW: And then early on with expenses, do you put off having kids? Do you put off homeownership?

PW: Oh, sure, yeah.

JW: So, there’s a lot of decisions.

PW: Man, that’s it, you’re going to have grandchildren, those types of things.

JW: And it might be the right lifestyle for some people. I’m not saying that nobody should do this.

PW: But the point is, you can’t predict it, is my point.

JW: Yeah, absolutely.

PW: It may be. You may luck out, but the reality of it is what I’ve seen. And Jim, I think about us, and I think about what we’ve done for years and years.

We work with people of all different age groups. We’ve got people that we work with in their 30s and their 40s and 50s and 60s, 70s, 80s, and up to 90s, actually.

I look at us as living in a time machine. Because I get to see what people want in their 30s. I get to see what they want in their 40s.

And I just notice that the changes are pretty dramatic. But when you’re in your 30s, you’re thinking you know what you’re going to want.

JW: And you don’t know what life is going to throw at you, either.

PW: Totally.

JW: In terms of not only personal, family, whatever, that type of stuff, but stuff that’s going to affect the whole lifestyle anyway, like you talked about sequence of returns, something else.

What about inflation? What about price? Say, I’m going to drive an RV across the country, and that’s what I’m going to do, and all of a sudden gas prices triple.

PW: Right. Or health, and that’s health of you or somebody else that you care about.

Delaying Living Your Life

PW: The other thing is that, and I think that’s the point you made, is delay living. Like you started to talk about, that was one of my notes that I made for myself.

Yeah, you’re delaying your living. You’re optimizing your spreadsheets, and you’re cutting all your expenses, and you arrive at financial independence, and all of a sudden your kids are grown. And your parents are gone. Right?

JW: Yeah, exactly.

PW: Yeah.

JW: But just talking to people about it, it’s about balance.

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It’s about living the best life you can now, but taking care of your future self.

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PW: No, for sure. And the thing is, is that retirement doesn’t solve the meaning problem, either. We often think If I didn’t have to work, I’d be happy. People think that.

But the research on retirement shows that people get purpose out of work. They get relationships at work. They get to grow moving forward. They get to learn new skills and constantly improve themselves.

And if you don’t have that driving you at all … And I think a lot about this radio show, and I’ve said this over the years. What I love about this radio show is it forces me to study, and it forces me to grow in ways that I probably would be too lazy to do if it weren’t for the show.

JW: I doubt that.

PW: Oh, come on, Jim.

JW: But I get what you’re saying.

PW: Just run with it, will you, for cripes’ sake?

JW: I know you well enough to know that I’m not sure that I would agree with that, but I get what you’re saying. I have that conversation all the time when people say, “Hey, I’m going to retire.”

“What are you going to do? Have you thought about that?”

And the answer typically is, “Well, a little bit, I just know that for six months I’m not going to do anything, and then I’ll see what happens and all that.”

What Will You Do After You Retire?

JW: It’s really worth giving some thought to because, especially, I mean, some people have such a social life and everything; they’re going to still be going 90 miles an hour the day they retire, but not everybody lives that type of life. A lot of people are more solitary and things.

They just like to, “Okay, I want to be around the house. I want to garden. I want to fix things.” But then you lose your social network, and that can, ultimately, be really detrimental to your health long term.

PW: Oh, yeah, that’s a really good point. Actually, yeah, you put them together. That’s a really good point that you’re making right there. The other thing that can change, too, is government policy.

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You don’t know when the government’s going to do something that causes an issue with your retirement, which forces you back to work for that particular reason.

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Let’s say that you have a lot of your money in pre-tax investments, and all of a sudden, tax changes occur. Or maybe the other thing where you pay taxes on things, now you have Roth IRAs, and all of a sudden, now they’ve changed from income taxes to consumption taxes.

Now you have a problem there: The cost of living has gone up, inflation, if you will — inflation due to tax policy. There are a lot of things you’ve got to think about regarding this.

And keep in mind that it sounds good. In theory, the FIRE movement, I’m not necessarily sure that it’s the greatest thing for people.

I think that there are a lot of drawbacks to it, and just a couple of them I want to make sure that you’re aware of here to think about. And just kind of, as my mother used to say, “Put that in your pipe and smoke it.” Okay.

Private Equity Added to Your 401(k)s

PW: So one of the things that has been a recurring theme over the past several weeks, Jim: Private equity, private credit has been a big thing, because 401(k)s, they’re adding this. Unbeknownst to a lot of investors, it’s being added to your 401(k)s, and you don’t even know it’s happening, necessarily. You end up with it in your investment portfolio.

JW: What could go wrong?

PW: Yeah, not even aware that it’s happening.

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Well, it may be happening to your portfolio because an investment adviser is adding it and you don’t know that they’re doing that. 

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I often tell people, I was talking to a friend of mine who said, “I got to come and see you.” And I said, “Yep, come on and see me.” Went to a dinner, yeah, yeah, one of those dinners, a steak dinner on finance.

And I was just shaking my head going, “Oh my God, SMH,” shaking my head. Those steak dinners, I have more about steak dinners in a little bit; just wait for this.

I think you’re going to get a kick out of this one. So anyway, the thing that we’re finding is that people will go out there, they’ll meet with somebody, they’ll sit down with a financial person, and the person says, “Hey, I think you need to do this, you need to do that.”

And people think, Oh, this is a huge investment firm that they work for. They must be doing good stuff. I mean, they wouldn’t be that big if it weren’t for them doing good things for investors. And as I’ve said, as we were talking about earlier, the investment industry is different from anything else.

There’s a friend of ours that likes to do this: He goes out and there’s, Jim, a software program that actually looks for lawsuits against the biggest investment firms and looks for where they’re sued. And he’ll go out there and say, “Oh, put your name of your investment firm in there and you’ll find some kind of a lawsuit or complaint against them.” And he makes the point that way, and I think that’s a pretty funny way of doing it.

Why Is Private Equity Added to Portfolios?

PW: But if we look at private equity, it’s getting added to investment portfolios, and the reason it was being added was because, well, there are just fewer companies to invest in these days. We need to have private equity to add because the number of public companies has been coming down. Now, more about that in just a little bit, but this investment adviser, that’s exactly what they did.

And the title of the article in The Wall Street Journal is, “One Investor’s Race to Get $80 Million Out of Private Credit.” And it said that this guy had convinced colleagues at his investment firm to pull the plug on one of their most successful recent investments.

Why? What’s going on there? Was it really successful? Not necessarily, let me put it that way.

It almost sounds like, “Oh, you’re pulling a plug on something that did really, really well.” Yeah, it did well, and then it did really poorly, and now they can’t get out of it, is the problem.

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It did well on paper, and that’s a lot of times what happens. Something does well, and you think it’s really a great investment — until you try to get out of it.

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JW: Like the roach motel of investments: You can check in, but you can’t check out.

PW: The roach motel. Yeah, there you go. That’s another one for sure.

Yeah. Those poor cockroaches. I mean, really.

So what happened? It says that a lot of investors ran for the exits. And he said, “And now it might trigger the right to limit redemptions.” And that’s exactly what happened.

He says, “We thought we were going to be early. And then we started to get nervous when it turned out we weren’t early enough,” is what he said.

“In the following months, the storm around private credit started intensifying and investors tried to pull out nearly $20 billion from private credit funds to make loans to highly indebted mid-sized companies in the first quarter of this year, forcing the funds to restrict redemptions.” And that’s the problem that you run into.

Types of Risk in Investing

PW: This is one of the things that we’ve talked about here is liquidity. There are different types of risk in investing.

You have market risk. Markets go up, and they go down. Just think of it as the ocean.

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The ocean goes up and goes down, and you have boats on the ocean, and they’re moving up and down. That’s what’s called systemic risk.

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You’ll have market risk, which is the risk of stocks versus fixed-income investments when you’re looking at bonds and those types of things. Then with bonds, you have to consider that there are risks even in bonds, which are fixed investments, which we think of as safe, but they can be really risky.

You can have a situation where there’s interest rate risk. If interest rates go up, bond prices can come crashing to the ground, and now all of a sudden you have a situation where you have interest rates going up and stocks going down as a result of it, and your bonds going down as a result of it.

JW: And typically, investments that have little risk typically aren’t referred to as junk.

PW: Right. And then you’ll have bonds that are referred to as junk bonds, is what Jim’s alluding to there. Yeah. So you can have that, and then that’s a risk, that let’s say that all of a sudden now the credit quality of the bonds has gone down.

Maybe they used to be A-rated bonds or BBB-rated bonds or something like that, and all of a sudden now they’re BB-rated bonds or single B-rated bonds. And now you have a situation where maybe interest rates haven’t done anything at all, but because the credit risk has gone up, now they’ve crashed for that particular reason. There are lots of different risks.

Well, one of the risks is liquidity risk, and that’s what we were dealing with. And this is one of the reasons that I have spoken out against this well before anything went wrong.

When they first started talking about doing this, what, a year ago, I guess it is, something like that now, a long time ago when they first started talking about adding these to 401(k)s, that was the first thing I said when I saw that, was that, “No, I’m not going on board this. This doesn’t make a whole lot of sense.” And I didn’t think it would happen this quickly that this went south.

JW: Yeah. Well, I just think in terms of people that are putting those into the plans, the 401(k) plans are very highly regulated.

PW: Right.

JW: And there are lawsuits all over the place in terms of somebody breaching their fiduciary responsibility, fees are being too high in certain plans, being forced into certain investments, buying company stocks, et cetera, et cetera. And this just seems to be going 180 degrees in the other direction because fees are higher.

Transparency is very limited on investments like that, and the quality of opportunities out there … Because they’re going to create these private funds just to get into the 401(k)s, and it’s just to get in the 401(k)s to pull fees from. It’s not necessarily meaning they’re going to be the best of the best investments that are out there in that area of the market anyway.

PW: Yeah. Yeah, that’s been a problem. So anyway, private equity, didn’t think it would happen this quick, but it’s happening.

Advisory services offered through Paul Winkler, Inc an SEC registered investment advisor. The opinions voiced and information provided in this material are for general informational purposes only and not intended to provide specific advice or recommendations for any individual. To determine what investments are appropriate for you, please consult with a financial advisor. PWI does not provide tax or legal advice. Please consult your tax or legal advisor regarding your particular situation.