A low-cost road to financial independence
4 minutes reading time
In recent years, the term ‘FIRE’ (Financial Independence, Retire Early) has become popular in investing communities on social media and YouTube. While there’s no shortage of gurus trying to sell you their ‘secrets to financial independence’ (spoiler alert: their secret is selling their courses at inflated prices), the reality is that achieving financial success can be relatively simple. No ‘tricks’ required.
However, simple doesn’t mean easy. The road to achieving this goal is straightforward, but getting there requires planning, discipline, and sacrifice. A bit of good luck also doesn’t go astray.
So, if ‘FIRE’ is the destination, what’s a vehicle that can get us there?
If the goal is to attain financial independence as soon as practically possible, there are a few things we need.
First, we need the tools to build a broadly diversified portfolio. There’s no point saving hard and investing heavily, if we then go and blow it all on a single company that fails to perform. Diversifying into a broad range of shares and other assets helps to mitigate this risk.
Second, we want to minimise our costs. We work hard for our money, and fees can really add up over the long term. Lower fees mean more money in your account. There are a range of fees for investors to consider, but two important ones are management fees and brokerage costs.
Finally, we want to keep it simple. If we’re saving and investing to achieve financial independence, that probably means we’re working full time too. And even if we’ve achieved it already, surely, it’s better to enjoy our hard-earned freedom, and not sit in front of a screen all day managing investments?
Thankfully, there’s a vehicle that can tick all these boxes: exchange traded funds (ETFs). ETFs offer diversified exposure to a wide range of assets and markets, such as shares and bonds, both Australian and global. They are generally low-cost, with some charging management fees of less than 0.1% per annum. Because you can buy a basket of shares or bonds with just one trade, they can also help to reduce brokerage costs. And ETFs are transparent and easy to understand.
Planning the trip
You wouldn’t set out on a road trip without a plan. The same principle applies to our financial journey.
Our plan requires some important elements:
- Knowing where we’re starting, i.e. our current financial situation. We need to consider our debts and assets, as well as our income and expenses. With income and expenses, it’s important to consider how they might change over time – for example, after paying off a house, or having a baby. It’s also important to keep superannuation in mind, as this may provide access to additional assets (and therefore, income) once you meet a retirement condition.
- Working out where we want to go, i.e. a realistic goal. We need to consider the type of lifestyle we want to live, and the income required to fund this. This is very personal, and there’s no right or wrong answer. In the FIRE community, there are different approaches to this, sometimes called “Fat FIRE” and “Lean FIRE”, which refer to living a lavish or a frugal lifestyle respectively.
- The road from point a to point b. Once we know where we are and where we want to go, we can calculate how much we need to save and invest to get there. If it turns out that the required savings rate is unrealistic, we may need to adjust our goals. ASIC’s MoneySmart website offers a range of helpful calculators, such as their Compound interest calculator.
At this stage of our journey, we may want to consider using ETFs that invest in shares.
Now our trip is planned, next comes the hard part: sticking to the plan.
The destination is not the end
Skip forward a few years, and we’ve arrived at our destination. We’ve achieved financial independence. Well done!
But this is not the end of the journey. Many people mistakenly think that investing stops when they retire, but all that really changes is the goals.
During the first part of our journey, called ‘accumulation’, the goal is to grow our investments. For many of us, as we get closer to retirement, the goal is increasingly to preserve our wealth. And this remains important during retirement.
But as we arrive at the destination, we have an important new goal – income. Now that we no longer get paid by our employer each month, we need to replace that income from our investments.
Luckily, the vehicle we chose earlier in our journey can traverse almost any terrain. ETFs aren’t just for accumulation; they can also be used for capital preservation and income.
Some ETFs invest in fixed income, which provides regular income to unitholders, and can add a defensive tilt to our portfolios.
For those comfortable taking more risk, equity income offers many of the benefits of investing in shares, but with enhanced income. In some instances, these strategies may offer lower volatility than general equity investments.
Some of these ETFs also offer monthly distributions, which can help in making the adjustment from working life to retirement.
We’ve made it to the end of our journey. Early retirement is a desirable goal and an enviable achievement, so enjoy the free time.
Formerly Managing Editor at Livewire Markets. Passionate about investments, markets, and economics.Read more from Patrick.