In personal finance circles, the term “FIRE” has raged hot recently.
It’s an acronym, standing for financial independence and retiring early. While everyone knows what retiring early means, financial independence means having enough passive income from your investments to cover your living expenses.
In other words, not having to work in order to pay your bills.
It is absolutely, 100% possible to reach FIRE in five or ten years. I’ve interviewed many people who have done it, and none of them had massive six-figure salaries or trust funds or any other “unfair” advantages.
But that doesn’t mean it’s easy. It requires uncommon discipline, a willingness to live on a fraction of your income and invest the rest. Beyond discipline, it also requires knowledge – but the fundamentals are easier than you think.
Here’s how to reach FIRE, leveraging rental properties to build enough income to pay your personal living expenses.
Step 1: High Savings Rate, Low Living Expenses
To start building a portfolio of investments, you need money to invest.
Sure, there are tricks to buy rental properties with minimal money down, such as borrowing a seller-held second mortgage and other creative financing tricks. But you still need cash and a lot of it. When you save more of your paycheck, two things happen:
1. You have more money to invest with, and
2. You have lower living expenses, and therefore a lower target income that you need to replace with passive income.
At the risk of stating the obvious, it’s easier to generate $3,000/month in passive income than it is to generate $10,000/month. If your target is only $3,000/month in passive income, you can get there far faster.
Your first mission is to cut your living expenses as low as they can go and maximize your savings rate. (For the uninitiated, savings rate is the percentage of your income that you put towards savings.)
For example, most people laugh when I ask them what it would take for them to reach a 50% savings rate. “A miracle,” they reply.
Yet consider your housing payment. Most Americans spend 25-50% of their income on housing. So if you removed your housing payment by house hacking, your savings rate would suddenly rise by 25-50%.
I don’t have a housing payment, and it’s been pretty miraculous for my savings rate.
Step 2: Invest for Passive Income
After cutting your spending and supercharging your savings rate, you suddenly have the cash to invest. It’s time to put that cash to work earning money for you.
Rental properties are a prime vehicle for passive income. You can forecast your cash flow and returns before buying, ensuring you only buy properties that generate a strong income. Use our free rental property calculator to run the numbers on any property to evaluate it.
One nice perk to rental properties is that you can largely finance them with other people’s money. That helps you bend the old 4% Rule, so you can generate more income with less cash. You also don’t need to sell off any assets in order to generate that income, and rents rise alongside inflation, expanding your income even as you pay down your principal balance.
But rental properties aren’t your only option for a passive income of course. Others include dividend-paying stocks, bonds, REITs, private notes, crowdfunding websites, and more.
Remember, as you start earning more and more income from your investments, you’ll have more to invest with. It creates a snowball effect for your income, accelerating your income growth as time goes by.
Step 3: Scaling & Diversifying
As you buy more properties and get closer to FIRE, your strategy should evolve as well.
First, you can’t keep using conventional mortgage loans to finance your rentals. Most lending programs allow a maximum of four mortgages reporting on your credit, and you wouldn’t want any more than that anyway for your credit’s health.
Most investors graduate to portfolio loans, seller financing, private financing, or local community bank loans. All are scalable, unlike conventional mortgages.
To minimize your cash outlay, one option is the BRRRR model: buy, renovate, rent, refinance, repeat. When you buy a fixer-upper and force equity by renovating it, you can then refinance it to pull your original cash investment back out of the property. That leaves you free to rinse and repeat, expanding your rental portfolio ever larger.
As you get closer to financial independence, consider shifting your focus away from speed and toward safety and stability. It’s a good time to pay off a mortgage or two, to buy more diversified investments, and to make sure you don’t rely too heavily on any one source of income. Consider buying dividend-heavy stock funds and REITs to help diversify your assets and income, in addition to your rental properties.
Step 4: Tracking Your Progress
There are thousands of financial ratios that experts and advisors flying around. I focus on three.
If you relentlessly push to improve these three numbers, you can’t help but build wealth and get closer to FIRE:
- Savings Rate: As outlined above, the percent of your income that you put toward savings and investments. I use the after-tax income for this calculation, if you can use before-tax income instead, just make sure you’re consistent in which number you use.
- FIRE Ratio: The percent of your monthly living expenses that you can cover with your passive income from investments. When this reaches 100%, you’ve achieved financial independence.
- Investable Net Worth: The sum total of your investment assets, minus any debts and liabilities. This does not include your primary residence, vehicles, or any other personal assets that don’t generate income.
That’s it. Keep growing those three numbers, and watch your wealth snowball.
Step 5: Finding Fulfillment After FIRE
I like to think of financial independence, not as the ability to do nothing (although it is that too), but rather the ability to do anything.
You can keep working on your job if you love it. Or go part-time, or switch careers to do something that pays less but means more to you, or invests in rental properties full- or part-time. Instead of working for money, you could volunteer full-time if you feel called to do so.
When the income from your rental properties and other investments can cover your living expenses, your current job becomes optional. But that doesn’t mean you should sit around watching TV all day. You have gifts and knowledge and passion, and the world needs them.
Instead of thinking in terms of traditional retirement, instead think about what you’d like to do with your second career, your next life. That’s the beauty of reaching financial independence at a young age: you aren’t limited by money or time. You can devote your talents to whatever feels most meaningful to you.
3 Risks of Early Retirement
Before you quit your job and storm out in a blaze of glory, there are a few financial risks you should account for.
Sequence Risk: Actually, sequence risk applies to all retirees, regardless of their age when they retire. It’s the risk of a market crash, within the first 5-10 years of retirement.
It turns out that a large market crash early in your retirement does far more damage to your portfolio than a crash later in your retirement. Sequence risk applies particularly to stocks, rather than rental properties: when each share is worthless, you have to sell more of them to generate the same income to live on, which depletes your stock portfolio quickly. By the time stock prices recover, your portfolio is so depleted that it can never fully recover.
Rental properties help, by providing ongoing income, as do dividends. If you can live on your rents and dividend income alone, you become almost impervious to sequence risk.
Healthcare: If you do choose to retire, or take a job that doesn’t provide health benefits, you’re going to have to pay for insurance on your own. And in today’s world, that’s not necessarily easy.
A few options include:
- Taking a part-time job with health benefits
- The Affordable Care Act exchanges
- Private health insurance exchanges
- Association health plans
- Moving overseas where health insurance is far cheaper (I myself live overseas and enjoy far more affordable high-quality healthcare).
Unexpected Post-Retirement Expenses: Life is unpredictable. You may find that you spend more money, with more free time on your hands. Or a sudden health issue could prove expensive, or a family member could suddenly need your help.
Always be prepared to earn more money, should the need arise. It’s one more reason to continue working in some capacity, even after reaching FIRE.
Far too many people work themselves into complacency, dullness, and old age. They find too little meaning and too much tedium in their work.
Working for a standard 45-year career is not your only option. Maximize your savings rate through house hacking and other tricks to save more and spend less. Start putting more money into rental properties and other income-producing investments. Run the numbers through a rental property calculator before investing and use conservative figures to make sure you earn money rather than lose it.
Life is too short to spend doing something you don’t love. By reaching financial independence at a young age, you give yourself the gift of freedom to spend the rest of your life however you like.
About the Author: G. Brian Davis is a real estate investor, personal finance columnist, and co-founder of SparkRental and FIRE from Real Estate. He spends ten months of the year traveling overseas, and two months home in the U.S. with his family and childhood friends. You can connect with him through SparkRental.com, SparkRental’s Facebook page, or his weekly 10-minute live video tips on Facebook.
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