Building a FIRE Portfolio with ETFs

Many people dream of retiring early. After all, life’s too short to spend so much of it slogging away at the daily grind of a 9-to-5. But making that dream a reality takes hard work and sacrifice. Our society may be geared toward instant gratification, but with enough resolve, you can aspire to achieving financial freedom.

The concept of Financial Independence, Retire Early (FIRE) has sparked the interest of people who don’t want to spend all of their most vibrant years in traditional employment. 

Understanding the FIRE movement

The heart of the FIRE movement is financial freedom. Proponents of this investment philosophy aim to leave the workforce earlier by living well below their means, saving 50-70% (or more) of their income, and investing aggressively. The ultimate goal is to reach the “FIRE number,” which you calculate by multiplying your annual expenses by 25. 

For example, say your living expenses are $7,000 per month, or $84,000 annually.  Multiplied by 25, this yields a target portfolio value of $2.1 million. Once you’ve achieved the target portfolio value, you can withdraw 3-4% of the portfolio value annually to fund living expenses. 

FIRE isn’t just about retiring early; it’s about having choices. Whether you want to escape the rat race, pursue a passion, or work part-time doing something you genuinely love, the FIRE philosophy centers on creating a financial foundation that can support your aspirations. 

By committing to aggressive savings and investment strategies, FIRE adherents can seek to accumulate wealth sufficient to cover living expenses indefinitely. This could make it possible to retire decades earlier than the standard retirement age of 65.

Why use ETFs in FIRE portfolios?

We believe exchange-traded funds can be an excellent choice for implementing a FIRE strategy, given their multiple benefits.¹ Some of the advantages of ETFs include:

• Diversification:  ETFs typically track indexes that cover most major asset classes and sectors, as well as many international markets. 
• Low cost: Many ETFs offer low operating expense ratios (OERs)—typically lower than those for actively-managed mutual funds.
• Liquidity: They trade just like stocks, making it easy to buy and sell as necessary during market hours.
• Transparency: Most disclose holdings on a daily basis.
• Tax efficiency: With typically lower turnover and an in-kind creation/redemption process, they usually pass through few capital gains.

Key strategies for building a FIRE portfolio with ETFs

To construct a robust FIRE portfolio, you need to mitigate risk, protect purchasing power, and generate reliable income for decades. There are some key strategies that can help you do this.

• Risk parity for stability: Risk parity seeks to allocate risk evenly across asset classes such as equity, fixed income, and commodities. By following this approach, you reduce concentration on any single market, thus seeking to achieve more stable long-term performance.
• Inflation protection: Inflation is one of the greatest threats to long-term retirees who are living off their portfolios, as inflation erodes purchasing power over time. To help mitigate this risk, consider ETFs designed to hedge inflation. They invest in assets such as Treasury Inflation-Protected Securities (TIPS), commodities, and industrial sectors widely perceived as historically having performed well during past inflationary periods. We believe such ETFs have the potential to provide a critical buffer against rising costs.
• Generating income with covered call ETFs: FIRE portfolios need to generate consistent income streams, especially after retirement. One possible option to aid in this objective is a covered call ETF. These ETFs generate income from the premiums realized by selling options on the underlying assets. This strategy has the potential to enhance income while providing continued exposure to equity markets. Selling a call option limits upside potential as the seller will be forced to sell the underlying stock if the option’s stock price rises above the strike price. Traditionally, the premium is intended to also provide a buffer when the price of the underlying stock declines,² although premiums are distributed to investors in this ETF strategy, thus generating income even when the market retreats. 
• Balancing growth and stability: Equities are an integral component of the FIRE strategy since they are intended to be drivers of growth. However, it’s also important to invest in more conservative investments to balance your portfolio. Fixed income is the traditional balancing asset class, so diversified bond ETFs such as broad-based U.S. Treasury funds and slightly riskier high-yield bond funds seek to offer stability during periods of market volatility. Holding fixed income funds can also help mitigate the risk of being forced to sell off equity during market downturns to cover expenses.

Managing and rebalancing a FIRE ETF portfolio

When you construct a FIRE portfolio, or indeed any portfolio, you begin with a target asset allocation. Since asset classes generate different rates of return, rebalancing keeps your portfolio aligned with your objectives. Some brokerage accounts offer automated rebalancing options for convenience.

Taxes are another consideration, as minimizing taxes is critical for early retirees. It’s wise to use tax-advantaged accounts like 401(k)s, IRAs, and Roth IRAs as much as you can. However, there are age requirements for withdrawals, so for expenses before age 59 ½, maintain a regular brokerage account from which withdrawals are penalty free. There are also ETFs designed to be tax efficient. And, strategies like tax-loss harvesting can help FIRE investors seek to preserve more of their gains.

It's vital to manage withdrawals carefully. Adjust for inflation annually and revisit the withdrawal percentage periodically to account for changing market conditions and life circumstances.  

Finally, look for ETFs that offer liquidity and diversification to help manage market volatility. You’ll want to ensure that you maintain sufficient cash and conservative investments to ride out any storms.

Risks to watch out for

FIRE investors need to be mindful of certain challenges:

• Market volatility: Markets can experience sharp downturns. Seek to help mitigate this risk by maintaining diversification and balancing risk parity strategies, inflation hedges, and fixed income investment.
• Longevity risk: Retiring early means that your assets need to last longer, and the average lifespan is increasing.³ Strategies taking advantage of dividends and covered call ETFs have the potential to generate steady income streams, reducing the necessity to make withdrawals from capital.
• Underestimated costs: Healthcare and unforeseen emergencies can derail early retirement plans. Build in an emergency fund with 6-12 months in living expenses, and ensure that you have adequate health, property, liability, and life insurance to protect yourself.
• Inflation: With inflation threatening the purchasing power of assets, we believe FIRE investors should take a non-negotiable stance when it comes to investing in inflation-protected ETFs.

The takeaway

The FIRE movement offers a compelling vision of financial independence and the opportunity to live your best life. To us ETFs offer the complete blend of flexibility, cost efficiency, and diversity to help you pursue this goal. Take advantage of these strategies to build a portfolio intended to help withstand market fluctuations and safeguard your wealth over time. With diligence and planning, even investors with modest incomes can take meaningful steps toward achieving financial independence.