Are We There Yet? Why Your FIRE Number Could Be Way Off

you and your FIRE number

Figure out your expenses.  Multiply them by 25 to get your magic FI number.  Hit that number.  Leave your job – and live happily ever after.

Simple enough – if you believe 99% of the personal finance articles out there.  Except it’s not.

On the contrary, there is a high degree of likelihood that whatever your “number” is, it won’t be the number that will actually allow you to pack it all in.

The real figure will likely be higher than the one you have in mind – and inflation is to blame.

The stock market, with its inevitable declines, corrections and the occasional “bloodbath”, makes for some very exciting headlines.  But while the journey may be volatile, over the long term the stock market is on a relentless march upwards.

Inflation has the opposite effect.  It’s quiet, unexciting and doesn’t dominate the headlines.  And yet, if you are not careful, it will slowly chip away at the value of your savings and erode your net worth until there is nothing left.

Bubble Gum

According to Investopedia, Inflation is a quantitative measure of the rate at which the average price level of a basket of selected goods and services in an economy increases over a period of time.”

If you are like me, you are probably re-reading that statement again.  Not very user-friendly, is it?

Thankfully, I’ve recently come across a far better explanation:

“When you were a kid, a pack of gum used to cost a nickel.  Now, that same pack costs a dollar.  The pack of gum hasn’t changed a bit – but the value of your nickel sure has.”

Now that’s something even I can understand.

The graph below provides a nice visual illustration of the effects of inflation over time.  Unfortunately, I haven’t been able to get similarly detailed data for the UK but I would assume it won’t look too far off:  Historical inflation

Over the past two decades, annual inflation ran at about 2.3%.  At first glance, that doesn’t seem like a high number.  But just like with investments, the effects of inflation compound over time – and not in our favour.

That tiny 2.3% inflation rate caused the purchasing power of a pound to decrease by a whopping 58% over the last twenty years.  In other words, you will now need £158 to buy the same goods and services you could get for just £100 back in 1998.

And depending on your age, family situation and spending needs, you could be even worse off.  As the red lines on the graph illustrate, life has gotten even more expensive if you happen to be in college, have kids, or be in ill health.

Economic theory posits that low levels of inflation can generally be a good thing.  And even if you happen to disagree, the fact is that inflation is something you need to contend with, especially in the context of financial independence.

So how do you go about it?

Nominal Thinking

One of the major challenges in financial planning is the notion of nominal versus real returns.  Typically, when you are forecasting your net worth, you think about it in nominal dollars.

For example, I have recently published a post on growing your net worth from zero to one million in 25 years.  In it, I’ve assumed nominal returns of 8% per year, in line with what the stock market has delivered historically.

Path to your first million

One of my favourite charts

I am confident that if you follow the plan in that post, you will become a sterling millionaire in 25 years.

I am also confident that being a millionaire in 2045 is going to be pretty damn awesome.  You will be able to buy all the bubble gum your heart desires.

Nevertheless, in absolute levels, it simply won’t be as much bubble gum as you could get for the same amount of money today.  The purchasing power of your money in 25 years will be lower than it is at present.

How much lower?  That depends on the rate of inflation.  But to give you a steer, here’s a table that shows the value of £1m in today’s money at different rates of inflation.

£1m inflation

(Un)real Returns

If you have a problem with that kind of forecasting, you could try forecasting based on real returns.  In practice, this means saying to yourself:

“Nominal stock market returns are 8% per year.  However, because inflation runs at 2% per year, the real return on my money is only 6%.  I am going to plug 6% into my model and see what comes out.”

This is a valid approach, and some people do use it.  Unfortunately, it has some serious drawbacks.

For example, you may be forecasting your future savings as a % of your salary.  Well, guess what – your salary is getting paid in nominal dollars.  Very soon, your calculations will start mixing real returns on nominal dollars, rendering the whole thing impractical.

Great Expectations

A better way may be to look at your expenses today and try to estimate what they will be in the future.

For example, if your monthly spending is £1,000 today and inflation holds at the same rate as in the chart above, you can expect to spend £1,580 on the same basket of goods and services in 20 years.

The one complexity here is that you will need to account for a possible change in your spending patterns:

Will you still have a mortgage in 20 years?  What will your family situation look like?  How will you spend your time and money?

None of these are easy questions to answer and you probably won’t get to a perfect answer.  However, with a bit of time and introspection, you could probably form a pretty accurate view.

The above approach might well be better than forecasting based on real returns.  However, there is a third – and final – alternative…

Embracing Uncertainty

One of the biggest lessons I’ve learned on my own journey is that building wealth can be anything but predictable.

Along the way, you are bound to have emergencies and windfalls, promotions and setbacks.  The longer the journey, the more of them you’ll have.  They’ll hit you when you least expect them.  Life has a habit of not fitting into an Excel spreadsheet.

The best approach may be to simply accept that financial independence is a moving target.  The closer you are to hitting the bulls-eye, the more concrete of a plan you can develop.  But if you are staring at it from twenty miles – or years – away, it’s best to focus on the process.

Live – and spend – intentionally.  Invest your savings – and track your progress.  Focus on your family.  Find meaning in your work.

But whatever you do, please don’t turn your life into a countdown to reaching your “number”.  Giving up happiness today for the sake of achieving financial independence (and life satisfaction) decades down the road is a horrible idea.  Because you aren’t happy with your life today, growing your bank account balance is not the way to fix it.

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Banker On FIRE is an M&A (mergers and acquisitions) investment banker. I am passionate about capital markets, behavioural economics, financial independence, and living the best life possible.

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12 thoughts on “Are We There Yet? Why Your FIRE Number Could Be Way Off”

  1. You’ve reminded me of a film I saw for the first time a couple of weeks ago. Up the Junction is a fascinating time capsule of London in 1967. A posh girl from Chelsea moves south of the river to work in a sweet factory in Battersea (you may well ask why, but we never really find out). I was startled by one scene where she goes to a second-hand shop and furnishes her new flat for a fiver! Five pounds was a lot of money in 1967.

    1. Very interesting – sounds like one could probably FIRE on a few grand back then!

      I’ve added the movie to my list, have always been curious to get a sense of what London was like way back when. It changed dramatically even in the ten or so years I’ve been here. Thanks for the tip!

        1. Banker On FIRE

          This is great, thanks for looking it up! Didn’t get all the way through as kids woke up from the nap but will finish up during the week. An intriguing time capsule of London

    1. Great link! Interestingly, inflation was even worse here in the UK. £100 twenty years ago is £174 in today’s money:


      Somehow your other link won’t open here but I’ll check out the full movie on my next long flight 🙂

    1. You are right – over the past 100 years or so the markets have returned just south of 10% on an annualised basis.

      I believe over the last 30-40 years the returns have been slightly lower though admittedly I haven’t got the precise numbers handy.

      Reason I use 8% is to be more conservative. Would rather get surprised on the upside!

      1. Aw thanks very much. It’s still so weird to think of my life as interesting and that other people continue to follow along! And yes better to be conservative. Expect the best, be prepared for the worst is one of my favourite sayings!

  2. Pingback: 20 Personal Finance Charts To Help You Build Wealth - Physician on FIRE

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