At the core, financial freedom is about cash flow. Cash flow from investments, such as real estate, is what provides investors with true financial freedom.

When discussing financial freedom / independence one can’t ignore the very popular FIRE (Financial Independence Retire Early) movement. Supporters and followers of the FIRE movement are quick to point out that focus should not be on the ‘Retire Early’ part of FIRE. Nevertheless, the idea of retiring early is enticing to a great many. Is retiring early really a possibility? What does the math show?

In this article we’ll get into the math as we compare two different financial freedom strategies. The first strategy involves investing in cash flowing assets such as real estate. The idea behind this strategy is to cover all living expenses from passive income alone.

The second strategy aligns more with the FIRE movement. This strategy involves rapid wealth accumulation until retirement, after which the retiree can withdraw money from the accumulated wealth.

Contents

• What is Financial Freedom?
• What is the FIRE Movement all about?
• Financial Independence Retire Early (FIRE) Bloggers
• Financial Freedom vs FIRE
• The FIRE Rules of Thumb
• Who Are Those Pursuing the FIRE?
• Early Retirement Pros and Cons
• Financial Freedom is About Cash Flow – Illustration
• 1. Financial Independence vs FIRE – The Math
• 2. Financial Independence vs FIRE – Comparing Net Worth
• 3. Financial Independence vs FIRE – Comparing Cash Flow
• 4. Financial Independence vs FIRE – Comparing Standard of Living
• The Need to Redefine FIRE to Financial Freedom Through Real Estate
• Conclusion

What is Financial Freedom?

To me, financial freedom means having enough passive cash flow, from multiple investments to cover all my expenses.  Ultimately, this means I won’t have to depend on a typical full-time job for financial stability. See Financial Freedom Definition for a more in depth take at this.

In my view, financial freedom and financial independence are interchangeable terms. 

What is the FIRE Movement all about?

Whenever the terms financial freedom or financial independence come up, many also think of the term FIRE.  This term stands for Financial Independence Retire Early.

The FIRE movement focuses on saving money primarily through a frugal lifestyle.  The goal of the FIRE movement is to accumulate a large sum of money in order to retire early.  The idea is to invest this money consistently and then to withdraw from this investment account to cover living expenses. 

Some suggest saving about 50% of take-home income until reaching a specific dollar amount.  Proponents suggest this goal should be large enough so that a person can withdraw around 4% of the target goal annually. 

This movement gained a lot of popularity, especially with the Millennial generation.  Naturally, the idea of retiring early can be very appealing.  Although there’s always been some skepticism surrounding the FIRE movement, it continues to be popular today. 

As can be expected, there have been a lot of critics of this movement.  Most of the criticism comes from the ‘retire early’ part of the phrase.  Indeed, financial independence or financial freedom does not have to depend on early retirement.

Mad Money Monster founder, Lisa, started on the FIRE journey, but she soon discovered a few things that didn’t set well with her. One of these things was the strategy’s focus on early retirement. Another one is what she describes as unrealistic nest egg expectations. See ‘5 Things I Hate About the FIRE Movement‘

Financial Independence Retire Early (FIRE) Bloggers

I honestly believe early proponents of this movement didn’t mean for the focus of FIRE to be on early retirement.  Instead, I suspect most early proponents were drawn to a catchy phrase and slogan – FIRE.

If you look around, you’ll notice that many of those that found success with the FIRE movement were also blogging about their experience.  As a result of the movement’s popularity, these bloggers were able to grow traffic and gain significant income. 

Indeed, many of these bloggers became very successful.  As an investor, I can’t blame them.  These astute entrepreneurs made money from their lifestyle and from teaching others about FIRE.

Financial Freedom vs FIRE

My view is that financial freedom is really about cash flow. Whereas the FIRE strategy is primarily about accumulation and a frugalist lifestyle.  This isn’t just semantics. 

Before I expand on this, it is important to note that the serious problem with the FIRE movement is that although many have found success with this strategy, many others can be led astray.  This is especially true for those who fail to see that the ‘retire early’ part of the FIRE strategy can significantly undermine financial stability. 

When I say financial freedom is about cash flow, please consider that a far better strategy to attain financial freedom is to invest in real estate (or similar investments) without rushing to retire.  Then later in life, the investor can grow cash flow to the point that cash flow can cover all living expenses without the need of a regular job. In doing so, the investor would experience tremendous financial freedom.

On the other hand, the FIRE strategy focuses on accumulating a large sum of money (presumed to be invested in the stock market) in an accelerated manner. And after accumulating wealth, the individual can retire early and make withdrawals from an investment account to cover living expenses. However, in order to successfully live off these savings for 30 plus years, a frugalist lifestyle is a must. 

The table below provides a comparison between these two strategies, Financial Freedom vs FIRE

FIRE Rules of Thumb

Supporters of the FIRE movement rely heavily on two basic rules.  The 25% rule and the 4% rule. 

The 25X Rule

This rule is used to estimate how much money an individual must accumulate in order to retire.  For example, if you estimate you need an annual budget of $40,000 during retirement, then you can retire when you have accumulated $1,000,000.  That’s 25 x $40,000. 

The 4% Rule

This rule is used to estimate how much an individual can withdraw each year from the accumulated retirement account, without depleting the account.  If you have $1,000,000 in your retirement account, then you can withdraw $40,000 each year. 

The 4% rule was developed by testing it against historical data over several years, including during market down turns.  A key claim is that no historical case existed in which the 4% rule exhausted the accumulated retirement account in less than 33 years. 

Please note this last part is extremely important if you want to retire early.  Financial advisors use the 4% rule when helping typical retirees, not 35-year-old retirees. 

Let’s say you want to retire at age 35.  The 4% rule is good for no more than 33 years.  This means you’ll be completely out of funds in your 70s, if you stick to these FIRE rules. 

The other thing to note is that that you’ll be on a downward trajectory when you are in your 60s.  So, rather than experiencing financial freedom at that age, you’ll be experiencing financial stress. 

Who Are Those Pursuing FIRE?

Before moving on, it is worth considering the demographics of those pursuing FIRE. 

Millennials  

As mentioned earlier, this movement has become very popular among Millennials. This is hardly surprising given Millennial’s reputation of having low attachment to their jobs and/or corporations.

Personal Finance Bloggers

In addition, it is popular among many personal finance bloggers.  Again, this is not surprising because many of these bloggers make money from writing about FIRE. 

Single Individuals

FIRE is very popular among single individuals.  This makes sense to me.  When I was single, I wanted to travel the world.  If someone would have told me there was a lifestyle and a financial strategy that allowed me to do that, I would have been all ears. 

Couples Without Kids

Likewise, there are couples that are adventurous, frugal, savers, etc.  Without having to worry about kids, the FIRE strategy would be more alluring given the potential of two incomes to start with.   

Having kids would make FIRE a near impossibility.  Imagine the difficulties of trying to raise a family while attempting to carry out the FIRE strategy.  There is no easy way to be frugal when it comes to things like kid related medical expenses.   

Saving money for kids to go to college is probably very unlikely with a frugalist lifestyle. 

Entrepreneurs

I suspect there are many entrepreneurs that have successfully retired early and are enjoying financial freedom.  I also suspect a large portion of them have cash flow from online businesses, real estate, and accumulated a substantial nest egg. 

The reality here is these individuals are still working, but they can dictate their terms.  Simply, they are not working a regular 9 to 5 job like most other people are. 

Not the Poor

In order to save money aggressively (a 50% savings rate), individuals need to have enough income to be able to make the numbers work.  This is only possible if the individual has a good paying job.  An individual making minimum wage and already living frugally won’t be able to save money aggressively.  Thus, the FIRE strategy is probably not for the poor. 

In fact, the opposite seems true, those that already have some financial success will be more likely to succeed with the FIRE strategy. 

Early Retirement Pros and Cons

The pros of early retirement are obvious. The biggest pro is time. We all wish we had more time. In fact, time is the truest measure of wealth. If you have time you are wealthy.

Aside from the things we’ve already discussed, critics of the FIRE movement also question the wisdom of retiring early.  I tend to agree with on this with critics.

A few years ago, I worked for a late 40s manager that came back to work after being retired for a few years.  My boss made a fortune in the stock market prior to the dot com bubble.  He was one of the smart ones that cashed out in a timely manner. 

As a result, he was able to retire in his early 40s.  By then he lived in Hawaii, was married and had two kids.  One of his complaints was that when he was retired he found himself hanging out with his wife’s friends, because all his friends were at work.

He came back to work after admitting he missed work and was no longer enjoying retirement. 

Proponents of the FIRE movement would argue that just because you are retired from a 9 to 5 job doesn’t mean you don’t have to work.  This is a very important point.  In fact, it is clear that those pursuing the FIRE will increase their chances of being successful if they figure out a way to gain additional income. 

Furthermore, FIRE proponents would say the it isn’t really that you are retired, but rather that you have the freedom to chose when to work and what to work on.  I think this helps explains why so many people pursuing the FIRE strategy are bloggers. 

Financial Freedom is About Cash Flow – Illustration

Most people are familiar with the fable of The Goose That Laid the Golden Eggs.  In the end the farmer in this story is unwilling to wait for the goose to lay the golden eggs.  Instead he kills the goose to get the golden eggs, only to find there are none.

Let me switch this story around.  Assume a cash flow investor approached the farmer just before he killed the goose.  The exchange would be something like this:

Farmer: I think I am going to kill the goose and get all the eggs at once.

Investor:  Wait, have you considered how many eggs there may be inside the goose?  It is a small goose.  What if there are only 5 golden eggs?

Farmer:  5 golden eggs would be worth a lot of money!  I will still kill the goose.

Investor:  Wait, what if there are only 3 golden eggs? 

Farmer:  3 golden eggs would still be a good amount of money!  I will still kill the goose.

Investor:  Wait, how much do you think 3 golden goose eggs are worth? 

Farmer:  Oh, I don’t know.  Maybe 3 years’ worth of wages? 

Investor:  What if I gave you 3 years’ worth of wages in exchange for your goose.  In that case you get the money now and you don’t have a mess to clean up after.  

Farmer:  Deal! 

You can guess the rest of the story.

In this modified story, the investor is focused on the cash flow he can gain from owning the goose.  The farmer on the other hand is focused on accumulation – golden eggs and/or cash. 

In the end, the investor will have enough cash flow to attain complete financial freedom.  The farmer on the other hand will have to live frugally in order to not run out of golden eggs and/or cash.

In this example, it is obvious the investor is the wiser of the two.  For some reason, in real life we sometimes have a hard time seeing things clearly.    

Financial Independence Vs FIRE – The Math

As an investor, I need to keep my emotions in check.  To do so, one of the things I like to do is rely on the math.  Often this math requires making general assumptions, but some math is better than no math. 

For this exercise, let’s assume we have two friends seeking financial freedom / independence.  Both individuals are 20 years old, they are smart, and already successful at a young age.  They both have a full-time job that pay well.  Each of them earns $40,000 a year, after taxes. 

In this exercise we’ll also assume an annual rate of inflation of 3%.  This affects the amount of take-home pay needed each year.  Consequently, we’ll also assume salary increases in the amount of 3% per year, to keep up with inflation. 

Meet Josh the Investor

Josh likes the idea of investing in real estate.  His plan is to save 15% of his take-homme pay.  After savings, Josh is left with $34,000 a year.  He could save more, but he doesn’t want to limit his lifestyle too much. 

Josh has opened an investment account with a discount broker, where he automatically invests his savings into growth oriented mutual funds. He hopes to grow his investments at a rate of 5% per year.

In the meantime, Josh is learning as much as he can about real estate and is already looking for investment opportunities.  He already figured out that if he can earn a 5% return on his money, he will have $50,000 saved up by age 26. 

With $50,000 Josh estimates he can buy a $166,000 investment property, assuming a down payment of 30%.  And he calculates this investment will generate annual cash flow at a rate of 2% the value of the property. That amount to $3,320 in the first year.

Josh intends to save his real estate cash flow (& invest in growth funds) to eventually purchase more real estate income properties. 

Meet Zach the Frugalist

Zach is more of a FIRE type of guy.  He is natural at saving money and is proud of his frugal lifestyle. Zach plans to save an amazing 50% of his take-home pay.  After savings, Zach is left with $20,000 a year. 

This is tight, but if he gets one more roommate, he is thinking he can definitely save a lot of money in a short amount of time.

Like Josh, he has an investment account with a discount broker and invests his savings into growth oriented mutual funds.   

Zach figured out that if he can earn a 5% return on his money, he will have just over $1,000,000 saved up by age 42.

He plans on retiring early and living from the money he saved up.

Financial Independence Vs FIRE – Comparing Net Worth

The graph below compares the projected net worth for both friends, from age 20 to age 80. 

Josh’s Net Worth

Josh’s net worth is growing fast.  This is due in part to the appreciation of his real estate investments. This exercise, assumes a modest appreciation rate of 2% annually.  And remember, this appreciation applies to the price of the real estate asset, not to the down payment amount. 

Another contributing factor to Josh’s growing net worth is his ability to utilize financing leverage (i.e bank financing) to acquire real estate investments. To recap, Josh only needs 20% to 30% of the purchase price of a real estate investment to acquire that investment.   

In addition, Josh is reinvesting the cash flow he earns from his real estate investments. This allows him to acquire even more real estate and grow his net worth.

Josh’s real estate investment are as follows:

• First investment – At age 27 he put down $50,000 to purchase a $167K investment property.
• Second investment – At age 34 he put down $100,000 to purchase a $333K investment property.
• Third investment – At age 42 he put down $200,000 to purchase a $667K investment property.

When he is not purchasing real estate, Josh keeps growing his investment account by investing in growth mutual funds. 

Zach’s Net Worth

Zach’s net worth is represented by the red line in Graph 1. If take a close look you’ll notice the red line slops up and then down. This is because his net worth kept growing through age 54, thanks to that 5% return on investment.  That’s 12 years after he retired! 

However, his network began declining at that point. He understands this is part of the FIRE strategy though. Nevertheless, a declining net worth makes him a bit uneasy.

The problem for Zach is that darn inflation.  At age 43 he will need to withdraw $39,472 per year, just to keep up with inflation. Nevertheless, according to the 4% and 25X FIRE rules, he will be fine if he accumulates a nest egg of $986,800. And he plans on saving just a little over that amount.

Financial Independence vs FIRE – Comparing Cash Flow

What is cash flow?  For investment purposes, I prefer the definition used in Richdad.com (from Robert Kiyosaki’s Rich dad poor dad website). 

“Cash Flow is an ongoing stream of income you receive from an investment. You may receive this money on a monthly, quarterly or annual basis, depending on the investment…”

Richdad.com

For example, cash flow from a real estate investment is the rent received minus all expenses such as mortgage expense, taxes, insurance, repairs, etc. 

Now let’s talk about cash flow from paper assets, such as stocks.  Let’s say you have $10,000 invested in dividend yielding stocks that provide a dividend of 1% per year.  This generates $100 in yields the first year, which you can spend as you please.  This is cash flow! 

Investment growth, on the other hand, is not cash flow.  If you have $10,000 invested in growth mutual funds and this investment grows by $500 in one year, you can’t call this cash flow.

This is an important clarification, because at the earlier stages of their financial freedom strategy, both Josh and Zack have invested their savings into growth funds.  Therefore, neither of them has actual cash flow.  All they are doing is growing their investment.

The first of the friends to gain cash flow is Josh.  He earns cash flow after investing $50,000 to purchase the $167,000 income real estate property.   

For this exercise we are going to say both friends switch their paper investments from mutual funds to dividend yielding stocks after they leae their full time job. This means they will both be receiving cash flow from their brokerage account, after retirement.    

Finally, there is one more important qualification.  In practical terms, cash flow should not deplete the cash flow source. 

According to the FIRE rules Zach is following, he will withdraw more money from his investment account than the cash flow he is earning through dividends. He isn’t withdrawing just cash flow. He is also withdrawing from the asset itself.  Nevertheless, for purposes of this comparison, let’s ignore this he is withdrawing more than just cash flow.

Josh’s Cash Flow

Josh’s TOTAL cash flow is represented by the yellow line, in Graph 2.  His cash flow comes primarily from his real estate investments, but he also has money invested in dividend yielding stocks.

Josh’s Real Estate Cash Flow

Below the yellow line you can see Josh’s real estate cash flow, which is represented by the solid black line.  As you can see, he only began getting cash flow from real estate after he bought his first property, at age 27.

This black line shows three steps, one at age 27, another one at age 34, and the last one at age 42.   These steps occur each time Josh acquires a real estate investment property.  Each step represents an increase in cash flow. 

His first investment property, purchased at a price of $167,000, generates cash flow of $3,340 on year one.  That’s 2% of the value of the property.  

His second investment property, purchased at a price of $333,000, generates cash flow of $6,660 on year one.

His third investment property, purchased at a price of $667,000, generates cash flow of $13,340 on year one. 

Keep in mind that as each property increases in value, his cash flow from that property will also increase. This is because real estate rents are directly proportional to the value of the asset.

Josh’s Stock Dividend Cash Flow

Josh’s dividend cash flow is represented by the black dashed line.  Again, Josh invested his savings in growth stocks all the way until he retired from his full-time job.  The growth he is gaining is not cash flow.

Cash flow begins only after he switches his investment strategy to dividend yielding stocks. This occurs after he retires from his job.  This is why the dashed line, starts at age 55. 

Zach’s Cash Flow

Zach’s cash flow is represented by the red line.  His cash flow situation is easier to explain.  Up until retirement, Zach had zero cash flow.  That’s because all his money was invested in growth stocks.  After retirement he switched his investment strategy to earn dividends.  And that’s when his cash flow starts. 

If you look closely at the red line, you’ll notice the line slopes slightly up for the first few years and then it peaks and starts sloping down.  This is because he is withdrawing more money from his account than he is earning in dividends.  In other words, he is withdrawing more than just cash flow. 

Again, one of the challenges for Zach is inflation.  If he didn’t have to worry about inflation he could withdraw less and live from dividend cash flow alone. 

Financial Independence Vs FIRE – Comparing Standard of Living

Josh’s Standard of Living

Josh’s standard of living is represented by the yellow line in the graph 3.  His standard of living seems moderately frugal at first. 

Saving 15% of his take-home pay means he is left with $34,000 at age 20 one to cover all living expenses. He increases his budget by 3% each year to keep up with inflation. This means he will need $132,431 at age 65 just to keep up with inflation.

However, as you can see in Graph 2 above, at age 65 he is generating $158,248 in cash flow! So he could definitely increase his standard of living if he wanted to.

Zach’s Standard of Living

Zach’s standard of living is represented by the red line in the Graph 3.  Saving 50% of his take-home income means he must be extremely frugal.  He can save the most on housing, but he must be frugal with everything.  Indeed, on year one, he is allowing himself only $20,000 to cover all living expenses. 

Ultimately this means sacrificing his standard of living, which he is happy to do for the purpose of building up a large nest egg. 

However, even after accumulating over $1,000,000 he still needs to maintain a frugal standard of living.  Consider that all things being equal, each year he needs more money just to keep up with inflation. 

By age 65 Zach needs $77,901 just to keep up with inflation, but as you can see in Graph 2, at age 65 he is only able to withdraw $49,621 from his account. He can’t afford to accelerate the depletion of his account.

Overall, Zach’s plan has been to live frugally, to save a lot of money, and then enjoy financial freedom. However, when looking at the overall picture he doesn’t seem to have much financial freedom at all, especially when compared to his friend Josh.

The Need to Redefine FIRE to Financial Freedom Through Real Estate

I can’t stress enough how valuable real estate investing can be to a financial freedom strategy.  

If you think about it, real estate is like the goose that laid the golden eggs.  Actually, real estate can be easier to acquire than the goose.  In our story the investor needed to have 3 years worth’s of wages saved up to pay for the goose.

When it comes to real estate, an investor only needs to have 20% to 30% of the price of the asset saved up.  The rest can be financed.  This financial leverage is one of the characteristics that makes real estate such a great investment. 

One thing I have not mention yet is the possibility of refinancing real estate to purchase more real estate.  In the example above Josh saved up until he had enough money to pay the down payment on an investment property.  Instead he could have used the equity from his real estate investments to acquire even more real estate property. 

Such strategy would further increase his leverage.  However, overleveraging can also be a bad thing.  If you have too much leverage and something goes bad you could end up losing everything. 

In addition to cash flow and leverage, real estate has other advantages that make it an exceptional investment.  Some of these advantages include appreciation, principal paydown, and significant tax benefits. 

Real estate can be so integral to a financial freedom strategy that I suggest the term FIRE (Financial Freedom Retire Early) should be redefined to Financial Freedom through Real Estate!  Now, that’s a movement I can really get behind.  I look forward to writing more on this. 

The video below touches on 4 characteristics of real estate we’ve been discussing (cash flow, appreciation, and tax advantages and principal paydown).

Conclusion

Financial freedom is about cash flow.  If you can have enough cash flow to cover all living expense, then you are financially free.  On the other hand, the FIRE strategy is about accumulation and a frugalist lifestyle.  In the end, a FIRE strategy that focuses too much on the retire early part can be detrimental to attaining financial freedom. 

When it comes to investing for cash flow, my favorite form of investing is real estate.  One of the main reasons for this is that real estate allows for the use of financing leverage.  In other words, an investor only needs 20% to 30% of the purchase price of a property to acquire that property.

In addition to providing cash flow and lending itself to financing leverage, real estate can also appreciate in price.  And if this wasn’t enough real estate has very attractive tax benefits. 

To be clear, there are many other great investments that produce cash flow, worth consideration. 

Regardless of the investment type, we would be wise to lean towards investing in the most passive types of investments. 

Finally, we can’t ignore the need to diversify.  Josh’s strategy combines real estate investing, stock growth investing, and dividend investing.  Adding cash flow from a website, book royalties, etc would create a very robust financial freedom strategy. 

If you are interested in learning more about financial freedom, I highly suggest  the article titled ‘The bridge to financial freedom’ to start with.  This article outlines the entire strategy for those pursuing financial freedom, regardless of their financial situation.

Disclosure

Please don’t take anything in this website as financial advice.  I am not a financial advisor.  I am an engineer with a passion for business and personal finance.  It is highly advisable you seek the help of a professional when it comes to your finances and making significant financial decisions.