Strategies for calculating your FIRE number with variable income

Understanding the FIRE Movement

The Financial Independence, Retire Early (FIRE) movement has gained significant traction in recent years, attracting individuals eager to escape the traditional 9-to-5 grind. Central to this philosophy is the FIRE number—the amount of money you need to accumulate to achieve financial independence and retire comfortably. Calculating a FIRE number can be complex, especially for those with variable incomes. This article delves into strategies for accurately calculating your FIRE number, even in the face of fluctuating earnings.

Determine Your Annual Living Expenses

The first step in determining your FIRE number is to understand your annual living expenses. This involves:

1. Tracking Spending: Use budgeting tools like Mint or You Need a Budget (YNAB) to track your monthly expenses over at least a year. This should include rent or mortgage, utilities, groceries, travel, insurance, and discretionary spending.

2. Identifying Essential and Non-Essential Costs: Break down your expenses into essential (fixed costs like rent) and non-essential (like dining out). This will help in adjusting your FIRE number according to lifestyle choices.

3. Considering Future Changes: Anticipate how these expenses might change in the future. For example, if you plan to have children, your expenses will change. Factor in potential healthcare costs or changes in lifestyle.

Establish a Reliable Income Baseline

For individuals with variable incomes—like freelancers, entrepreneurs, or those in commission-based jobs—establishing a reliable income baseline is crucial.

1. Review Historical Earnings: Look back over the last three years and calculate your average income. Pay attention to seasonal variations and any trends in increase or decrease in income.

2. Use Multiple Avenues for Forecasting: If you have several income streams, include them all. Consider conservative estimates for those with variable components, such as bonuses or commissions, and ensure your average takes into account off-peak periods.

3. Emergency Fund: As a safety net against income fluctuations, maintain an emergency fund to cover at least 3-6 months of living expenses. This will create a cushion to protect against low-income months.

Calculate Your FIRE Number

Once you have a solid understanding of your expenses and income, it’s time to calculate your FIRE number.

1. The 25x Rule: Use the widely-accepted formula of multiplying your annual expenses by 25. This is based on the 4% rule, which suggests that you can withdraw 4% of your savings each year without exhausting your funds.

   • Example: Annual expenses of $40,000 x 25 = $1,000,000 FIRE number.

2. Adjust for Variable Income: Since your income may fluctuate, consider adjusting your calculations. Use the lowest income periods as a basis for the FIRE number, or calculate using a higher multiple (like 30x) to create a buffer for uncertain months.

3. Inflation Consideration: Adjust your living expenses for inflation to ensure your FIRE number holds its value over time. Historically, an average inflation rate of 2-3% per year should be added to your calculations.

Maintain a Dynamic Budgeting Strategy

With variable income, your budgeting strategy should also be flexible.

1. Use a Zero-Based Budget: This allocates every dollar of your income to expenses, savings, or debt repayment. It’s particularly useful during high-income months, allowing you to allocate excess income to investment accounts.

2. Savings Rate Monitoring: Set a specific percentage of your total income that you aim to save each month. In prosperous months, save more; in lean months, stay within your essential expenses.

3. Annual Income Review: At year-end, evaluate your total income against your FIRE projections. Adjust your FIRE number according to actual spending and income earned, refining your strategies accordingly.

Investment Strategy Alignment

Investing wisely is critical to reaching your FIRE number; variable incomes can complicate this process.

1. Diversify Investments: Spread your investments across different asset classes, such as stocks, bonds, and real estate, to mitigate risks. A balanced portfolio can yield stable returns even when your income fluctuates.

2. Consider Index Funds: These low-cost investment vehicles provide the potential for steady returns over long periods. They require less monitoring and are a great strategy for those with irregular cash flow.

3. Automate Contributions: Set up automatic transfers to investment accounts when you experience a high-income month. This ensures you consistently build wealth without being overly impacted by your income’s variability.

Calculate a Safe Withdrawal Rate

The withdrawal rate (to fund your retirement) will impact your FIRE number.

1. Adjust Withdrawal Rate Based on Market Conditions: Given market volatility, consider adopting a variable withdrawal rate. For instance, withdraw 3-4% when markets are performing well and reduce withdrawals during downturns.

2. Revisit Your Withdrawal Strategy: Use financial simulators to understand how your portfolio might withstand various withdrawal strategies. This can help in identifying a withdrawal rate that safeguards your longevity.

Leveraging Side Hustles

For individuals with variable income, side hustles can strengthen financial stability as you approach your FIRE target.

1. Explore Passion Projects: Freelance work or side gigs aligned with your interests can bolster your income without burning out. This can add a cushion for slower months.

2. Create Passive Income Streams: Consider investing in rental properties or dividend stocks that generate income without active involvement. This can stabilize your income, making it easier to meet FIRE targets.

3. Continuous Skill Improvement: Invest in courses or training related to your field to elevate your earning potential. Higher skills often lead to increased demand and income opportunities.

Monitor and Adjust Regularly

Your financial situation will evolve, making it crucial to revisit your FIRE calculations regularly.

1. Quarterly Discussions: Set quarterly reviews to adjust your financial strategies based on current income and market conditions. Don’t hesitate to adapt your FIRE number and investment approach as life circumstances change.

2. Stay Informed: Keep abreast of economic conditions and trends that can influence your income and expenses. Continually assess how these factors influence your net worth and future financial goals.

3. Seek Professional Guidance: Working with a financial advisor can provide tailored strategies that address your variable income and help refine your FIRE number, maximizing savings and investment effectiveness.

Conclusion

Understanding and calculating your FIRE number with variable income adds complexity, yet with detailed planning and adaptive strategies, reaching your financial independence goals is attainable. By combining thorough expense tracking, diligent income management, sound investment planning, and regular reviews, aspiring individuals can align their financial objectives with their variable earnings. Implement these strategies to navigate the FIRE landscape successfully.