As you explore the FIRE movement, you will quickly learn that investing is a key component of financial independence. You might be thinking that now is the right time to invest. After all, there’s a good chance you’ve heard more than a little talk lately about “buying dips” and taking advantage of the recent market downturn. But how do you get started when it comes to FIRE investing?
I sat down with JL Collins, the writer at jlcollinsnh.com and author of The Simple Path to Wealth, to learn more. There’s a reason MarketWatch calls his book the #1 book to read if you want to retire early. His simplified investing wisdom has helped thousands of readers in their pursuit of wealth and financial independence.
During our talk, he shared his own investing history. He also breaks down index fund investing and explains how to know which account to fund first. JL also offers an overview of how to get started investing for financial independence.
How JL Collins Started Investing for Financial Independence
JL says that when he first started investing, there was no concept of FIRE. At least, there wasn’t a concept that was widely discussed or even defined. While JL wasn’t pursuing FIRE by name, he certainly understood the appeal of financial independence.
An Early Understanding of Financial Independence
Growing up, he watched his father have a serious business reversal. When his father’s ability to earn money failed, so did their family’s lifestyle. His father was not a saver or an investor, so it was difficult for the whole family when that income stream dried up.
At a young age, JL says he realized just how financially precarious the world can be if you don’t take steps to guard against that. He knew he wanted to have a financial buffer to avoid falling into a similar situation when he got older. Though he knew he wanted a buffer, he didn’t know where to start.
The Power of Saving Half
When he first started working, he made it a point to save half of his income. However, he says it was like wandering in the wilderness. His savings habit was incongruous with that of his colleagues. Plus, he wasn’t even sure what to do with his savings.
After he had set aside about $5,000, he walked into a brokerage office and said he wanted help investing. Like many new investors, he didn’t really know what he wanted. He recalls asking for something safe for his money. Shortly afterward, he ended up investing in Texaco, an oil company, and Southern Company, a utility company. He was rewarded with handsome dividends. Looking back, he says he recognizes how the broker helped him make a relatively conservative investment. JL even acknowledges that this investment would have served him well. However, as soon as the stocks started to climb, he says he got trigger-happy and sold.
This is exactly the type of investing that JL now cautions against. He says that he reached financial independence picking individual stocks and owning actively managed mutual funds. However, he realizes that this was inefficient. Essentially, he took the long way on his journey to financial independence. That’s why he gives dramatically different advice.
A Simpler Way to Start Investing for Financial Independence
The concept of financial independence is appealing. It can also be overwhelming if you don’t know where to start. That is why JL gives a scenario to help people focus on the first step.
Imagine you are 30 years old. You’ve recently discovered the FIRE community and you are wondering about investing for financial independence. The very first thing you need to do is take inventory of what you can actually save and invest.
If you’re like most Americans, you likely don’t have a very high savings rate. Many Americans actually live paycheck to paycheck. Some might be saving 5-10% of their income. While that might put you on track for traditional retirement, that isn’t going to get you to FIRE.
That’s when JL says you need to look at your expenses. Take some time considering how you can organize your life to live on a lot less. The idea is simple, but JL says that this is actually a very difficult step. Unwinding a lifestyle you are accustomed to is challenging.
To help with that challenge, JL stresses a focus on financial freedom. He says you want to ask yourself how important financial freedom is to you. Looking at saving and investing as a way to buy your freedom can help you make hard choices.
Then, as you start to spend less, you can save and invest more. When your income increases, you want to avoid lifestyle inflation. By doing that, you will be able to save and invest even more. Growing the gap between what you spend and what you earn is the basic principle of FIRE investing.
Related Post: FIRE Movement – The Pros and Cons of Pursuing Financial Independence
What is Index Fund Investing?
Before you can appreciate why investing for financial independence often involves index funds, it is important to know what an index fund is.
In an actively managed fund, a fund manager has to figure out which companies and stocks will do better than others. JL says this is surprisingly difficult to do over long periods of time. Beating the market is difficult. Actively managed funds also come with a price. These funds have to pay their fund managers and that cost is passed onto investors in the form of higher fees.
Index fund investing, on the other hand, doesn’t involve trying to pick the best companies. Instead, an index fund allows investors to buy everything in the index. That means when you invest in an index fund like VTSAX, you own a slice of every publicly traded company in the US.
By design, you don’t have to worry about which companies will outperform and which will fail. JL says there is a “self-cleansing” aspect of index fund investing. What he means is that companies that fail, fall off. New and exciting companies are added, and of course, the top-performing companies stay.
Another aspect of index fund investing is that it offers a lot of diversification within a single fund. Many people over-complicate their investment portfolio in the name of diversification. Currently, an index fund like VTSAX makes you a partial owner of over 3,600 companies. Some may fail while many others succeed. That is the very idea of diversification, and it happens all within a single fund.
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Why Index Funds Are the Best Investment Choice
JL Collins is quick to point out that index fund investing isn’t the only investment strategy. It’s also not the only way to achieve financial independence. However, JL argues as far as investing goes, indexing has two things going for it:
- It is more powerful
- It is easier than other types of investing
Various studies show that it is almost impossible to outperform the index over any significant amount of time. Professionals can’t consistently beat the market. That fact coupled with fees that are significantly higher than index fund fees make indexing a compelling choice.
JL also says that indexing is simply easier. For the vast majority of people, they don’t want to spend all of their time investing. Instead, they simply want to get a few things right and focus their energy elsewhere. Index fund investing allows exactly that.
Where to Start Index Fund Investing
Once you have some room in your finances to invest, where do you put your money? JL has two thoughts on where people should invest their money. He says it really depends on if you are already an investor or are just getting started.
As someone who is already an investor, you want to focus on low fees. If you are investing with Fidelity, Vanguard, or another low-fee brokerage, you are on the right track. In fact, JL says that an index fund is an index fund. The Fidelity index fund is very similar to the Vanguard fund. They might track slightly different indexes at times, but they usually yield very similar results. If you like the firm you are with and the fees are low, you shouldn’t feel compelled to change.
However, if you are new to investing, JL says he always recommends Vanguard. While Vanguard is similar to other brokerages in some ways, its structure is unique. When someone invests in Vanguard, they become an investor and an owner. That means that Vanguard isn’t trying to serve its investors and owners separately. JL says companies like Fidelity ultimately have two masters, you and their owner. While this is a common business model, JL prefers Vanguard’s structure and philosophy.
Related Post: 3 Smart Reasons for New Investors to Choose Index Funds
How to Decide Between Tax-Advantaged Accounts and Taxable
Someone can do index fund investing in tax-advantage accounts and taxable accounts. There is a strong possibility as someone in the FIRE community that you will do both. So where do you start?
Like many personal finance experts, JL suggests using tax-advantaged accounts first. By prioritizing tax advantaged accounts like a 401K or 403b, you reduce your taxes now. As a working adult, you are likely on the way to your peak earning years. That means the higher your income, the higher your tax bracket. If you invest in tax-advantaged accounts with pre-tax money, you reduce your tax burden now. When you start to draw down your portfolio in later years, you will likely be a much lower tax bracket.
Investing in your tax-advantaged accounts first offers another benefit as well. JL says that putting money into those accounts now allows more money to be invested and grow more over time.
As you progress with investing for financial independence, there will likely become a point where you max out your tax advantaged accounts. If you have already invested the maximum amount in your 401K and IRA, then you should start investing in your taxable account.
Key Takeaways on Investing for Financial Independence
Financial independence is a powerful concept. Even in the midst of an economic crisis, more and more people are seeing the value of financial freedom. The road to FIRE can seem complicated, but investing for financial independence is much simpler than it seems. By focusing on reducing your expenses, growing your income, and taking advantage of index fund investing, you are on your way to wealth and freedom.
Are you investing for financial independence?
Please let us know in the comments below.
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4 Comments
Hi Andy,
My name is also Andy. I invest in Vanguard index funds and I’m pursuing financial independence to retire early.
I’m trying to get my fiancé on board with the goal to achieve FIRE. Do you have any advice on how to go about doing that when your partner doesn’t seem too interested?
Thank you,
Andy J
Andy! Thank you for asking this question.
Here is my best stab at an answer.
https://marriagekidsandmoney.com/how-do-i-get-my-partner-on-board-with-financial-independence/
so if i’m going down the road to FIRE – when moving funds from an actively managed fund to an index fund, are there tax considerations i need to look at before making this transition?
Hi Steve!
Depending on how your accounts and investments are put together, there could be tax considerations to keep in mind.
Consider meeting with a fee-only financial planner to help you make investing decisions before making any changes to your plan.