For the last couple of years since I’ve discovered the concept of Financial Independence Retire Early (F.I.R.E), I was chasing it while spreading the word to folks around me. The look of amazement and polite disbelief I get upon sharing my plans to “retire” in 10 years is oddly… isolating.
I realized the seriousness of the state of conditioning of the masses. Many are still on the mindset that you have to work till 65, else how can you afford the things you need today? By “afford”, it means servicing the loan for the car, loan for the house, credit card installments, bills, children’s education and eating out. The salary is to be allocated for those monthly payments. If there’re any leftovers, perhaps there’s consideration for a bigger house, a better car or that new phone change that’s about due. Retire in 10 years? Whose gonna pay those bills?
I can understand how F.I.R.E. celebrities, like Mr Money Mustache (MMM), a living example of someone who actually retired in his 30s, can be such a hit. Someone’s actually done it. How?
Well, according to MMM, its really simple. Work, spend less than you earn, pay down your debts and put everything else into investments. Eventually, your investment earnings start to snowball exponentially and eventually, reach the critical mass to outgrow your annual expenses. Then you’ll be set. The secret is cutting out the fat — lesser of things not bringing value to your life. Less car, less house, less cable, less eating out, less lattes, lesser of everything. Towards a more sustainable lifestyle and economy. Want to retire earlier? Tone down the spending by several notches.
At least that’s how MMM did it in 2005. He retired at just 30 with a portfolio of $600,000 and lives on about $25,000 annually. So assuming 5% annual growth, his 4% withdrawal rule works out more or less. The math doesn’t lie.
However, something just doesn’t seem quite right.
Don’t get me wrong, I’m all for a more sustainable way of life. In fact, the F.I. concept helped me to build up my F.U.$, which I am thankful for. It gave me options during circumstances that would’ve otherwise left me in out in the cold.
However, I did not just give up my Permanent Portfolio and go all in on low-cost index funds, like what MMM and JL Colins, another popular F.I. celebrity, would recommend. As I’ve said, something just doesn’t add up.
It took me a while, but I believe I’ve managed to put my finger on what’s bothering me all these while.
The Economic Contradiction
Proponents of F.I. insists that stocks have always only ever gone up in the long run. Even in a rare “black swan” event, which is an unlikely major correction, stocks have always came back with a vengeance… recovering and achieving even greater heights than before. It is hard to disagree, just look at the chart showing the closing values of the S&P 500 going back to the 1950s. Based on that, it makes perfect sense to double down during any “rare events” of a market correction. A perfect buying opportunity to average down for even greater gains.
The S&P 500 index is considered one of the most well-represented indices of the U.S. stock market as it contains the top 500 companies by market capitalization, having common stock in the New York Stock Exchange (NYSE) and NASDAQ. Its constituency is considered one of the most diverse due to its weighting methodology. Common stocks are considered the leading indicator of business cycles by the National Bureau of Economic Research.
What does this all mean?
It means the index represents 500 of the most valued companies. People value companies because of their growth potential. And how do companies grow? Through their revenues of course. Which brings the next question.
Where do these revenues come from?
All companies, whether their services are business to business (B2B) or business to consumers (B2C), ultimately derive their earnings from consumers. That means Us. We are at the bottom of the food chain where the ultimate value of all companies are drawn from.
It doesn’t matter if its the S&P 500 Index Fund or the Vanguard Total Stock Market Index Fund. They are all stocks of companies. Companies that ultimately derive their earnings from us.
In order to achieve exponential growth in returns to stakeholders, or owner of their stocks, these companies need to increase their income revenue. Here I’ll need to pull out my favorite quote again — a quote that has provided me more closure to many of my doubts about the economy.
One person’s spending is another person’s income.– Ray Dalio
Here’s where the problem comes in.
These companies need us to spend more.
The marriage of “sustainability” and “exponential growth” in the concept of F.I is counter-intuitive. You see, we can’t have all of us living a sustainable lifestyle, yet have all our investments achieve exponential growth at the same time.
Think about it. For the largest companies to be as large and as valuable as they are today, how much growth they must have attained all these years. When annual earnings are reported, even if the rate of expansion is constant, actual figures are in fact, much larger. Take 5% growth for the last 3 years as an example — it is 5% on the total cumulative earnings of last year, which includes the cumulative earnings from the year before that (5% of 100 is 5, 5% of 105 is 5.25, 5% of 110.25 is 5.5125). Therefore, even if the percentage growth is the same each year, it results in a much larger actual figure annually — and companies are expected to maintain or increase their performance to remain “valuable”. This is the much hyped-about exponential growth, the result of the famous power of compounding.
For our economy to grow consistently every year, every company has to exploit the earth’s resources for production to satiate an ever increasing demand. We live in a world of finite resources and the expectation of exponential consumption of finite resources simply cannot happen.
Another living organism that exhibits behavior of exponential growth, is bacteria — and they do so until they exhaust all available nutrients within the closed environment , before the population starts to die off.
Do you see the problem NOW?
The Debt Dilemma
If the marriage of sustainable living and exponential growth doesn’t bother you (perhaps it’s assumed that there will always be more people who can’t be bothered with delayed gratification), let’s have a look at another key element of F.I.R.E.: Paying down of debt.
Again, don’t get me wrong, I’m not saying that paying down your debts is wrong or bad. I’m just trying to figure out how it fits into the picture… and it doesn’t.
If you’re not aware, we’re all currently part of a debt-based monetary system. This means that every dollar that is in circulation today, since the days before and possibly in the near future, have been and will be, borrowed into existence.
The monetary supply of today is the outcome of unpaid debts circulating as currency. Currency that is used to buy stuff, including paper investments such as stocks and bonds. The same currency that is being devalued with the creation of more debt. When more currency is in circulation than actual goods or services available for purchase, each unit of currency will be worth less and stuff becomes more expensive. Its simple math — to determine price, just take a really large number as our currency supply, divide it by a smaller one representing the available goods and services… and you’ll get what I mean. This is why as more debt is issued over time, more currency is needed to purchase stuff, which includes stocks and bonds.
Food for thought: Does this mean these investments are valued more? Anyway, back to topic.
On the contrary, when debt is being repaid, the liability is extinguished, and currency disappears. The odd thing is that prices do not adjust downwards with the fall of the currency supply as quickly as people starting to feel poorer due to owning less currency. Think about it, when you pay back your debt, do you have less money on hand? This makes people spend less — and the revenue that is much needed by these companies to prop up their growth, begins to dry up.
In fact, when people spend less, that is when companies then begin to know that they need to lower their prices. However, that still means less revenues. Stock prices fall. People who own stock feel even poorer and spend even less. The cycle feeds itself and we get a deflation.
Investment income falls. Time to wake up.
The F.I.R.E. Cannot Spread
Once again, what is the basic formula to retire early and perpetually live off your investment income?
- Be Frugal
- Avoid Debt
- Invest (preferably in stocks)
These are all very good qualities for any individual to practice and can position said individuals at an advantage during difficult times.
However, is the concept sound in the context of our current economy?
Our economy hungers for more debt and resources to grow. Frugality and debt avoidance are acts that remove currency from circulation, starving the economy of one of its primary sustenance. Without it, growth will stop and it will eventually die.
Unless the F.I. community is saying that a line be drawn that separates those who have achieved or discovered the concept of F.I.R.E., from those who have yet to do so — and to survive off them.
In that case, how many people in the world can pursue F.I.R.E. before the system tips over?
Unless it is suggesting that the F.I. community lives off the spending of those who can afford to live the unsustainable lifestyle. The top 5% of the richest, perhaps.
Well, there’s only so much the richest in the world can consume. There’s only so many iPhones they can buy, so many cars that they can collect, so much food and drinks they can take. There’s only so much they can spend. Will it be be enough to support the growth of the economy?
Even if all manages to work out. How long will it last?
The F.I.R.E. cannot spread, because with more lemmings on board, everyone is going to fall off the cliff.
These are the fundamental issues with F.I.R.E. and it revolves around the heavy dependence on the returns of the economy as its primary supporting pillar.
To be fair, continuing to be productive after achieving F.I.R.E. is heavily promoted — in fact, one of the purpose of F.I.R.E. is to allow one to pursue his/her own interests with the hopes of profiting from it. So should the system fail, it is assumed that the alternative source of income will continue to sustain one’s standard of living.
However, going all in on stocks, or even a stock-heavy stock/bond portfolio, is a huge gamble… with very unfavorable odds… and with no less than 10 years of your hard work at stake.
Assuming that stocks will only go up, especially after every major correction, is not looking at the bigger picture. The F.I.R.E. community should start asking questions related to the fundamentals of our economy.
Questions like: What has been causing the value of stocks to go up all these years? Is it real productive value? Or is it the result of artificial manipulation meant to keep everything afloat?
I don’t have the answer to the last question. But I do know it is definitely not forever. Exponential growth into perpetuity does not work on finite resources. Never has and never will.
The math doesn’t lie.
With a better understanding of the way our economy works, a pursuer of F.I.R.E. may want to consider diversification to protect what he already owns. Not diversification into stocks as that has been largely covered by ETFs, but to consider portfolios with an asset class seldom mentioned by the F.I. community — gold.