7 stages of financial independence

Are you striving or dreaming to become financially free? Does financial freedom sound like a dreamland to you? What if you’re already financially free? What exactly is financial freedom? Well... the list could go on and on, but, Financial Independence (FI), for instance, is often defined as having enough money to live a comfortable life without needing to work more. But, does this definition hold true for EVERYONE? As much as it sounds exciting, financial independence, in fact, has a million different meanings depending on who you ask — it can mean everything from money never being an object again to just having the flexibility to work for yourself if you want to, even if it means you have no desire to ever quit working. It could also mean not needing to worry when you retire, including the freedom to travel, spend time with family members, relax and/or enjoy the “fruits of your labor.” 

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Long story short: financial freedom is a lofty dream, but it will likely only happen if you are willing to go after it.. Afterall, who wouldn’t want the security of knowing they’re ready to cope with emergency costs that pop up from time to time?

If you are determined that financial independence is what you want, then you’re in the right place. In this article, take a look at the 7 key milestones to becoming financially independent depending on where you are on your financial journey as well as what is the best way for you to achieve true financial independence.

So, shall we get into it?

This brings us to why smart money management is at the centre of FI

Working hard enough to obtain a position or sizeable wage, exploring various income streams or starting a business because it's much more lucrative than being a salaried employee are all examples of smart money management. It also pertains to your economic ideology, financial objectives, saving, spending practices, etc. 

As you can probably tell, it involves a considerable amount of time to plan this step-by-step approach to really get to that special place known as financial independence. It’s not at all easy unless you’re born rich or have generational savings or hit the lottery.

Which is why most people start very passionately to plan and work really hard for the financial freedom they have always desired. However, much like a new year's resolution, this FI wannabe fever gradually fades as people start to feel the need to put so much commitment into it. Yep, your time and effort… Not just one day, a week or a month, but an ongoing commitment until you reach FI.  As Paulo Coelho says in “The Valkyries”:

“Overnight success takes decades of daily work”

Nevertheless, retirement planning, or even financial freedom is not a sprint, it’s a MARATHON. That is why breaking down your financial independence objectives into smaller chunks is an integral part of fulfilling FI successfully, because it will help you stay on track while making the process more realistic and ideally, less stressful. This also means, you might need a "a modest amount of money you consistently invest," says Robbins, writer of Money: Master the Game: 7 Simple Steps to Financial Freedom, a new 700-page book. It contains insights gathered from his interactions with over 50 top financial gurus, including Warren Buffett, Charles Schwab, Carl Icahn, Steve Forbes, Vanguard founder John Bogle and hedge fund manager Ray Dalio.

His goal for the new book is to "help the average individual to cut through all the intricacy and mythology that is marketed to us about how you really can't handle your own financial affairs and show them that the finest people on the planet have given them the guiding principles and steps to go from wherever they are monetary to where they truly want to be." In other words, even if you are starting small, the important thing is to get started. So let’s get started on the 7 stages to FI, shall we?

The 7 Stages to Financial Independence:

These seven stages of financial freedom are quite beneficial for instilling excellent money habits in you. These habits will stick with you for the rest of your life and you will be much better in the long run. Let’s just say, this is a fundamental prerequisite for an effective money management plan.

●     Stage 0: Total Financial Dependence

If you earn less than you spend or if you do not earn anything at all, you are in the dependent stage. You are a dependent if you rely on your parents' assistance or any other type of monetary help from a third party.

So, the very first level of financial freedom is earning well and especially building up some savings, emergency funds and/or  income. To be totally financially independent:

Do daydream a little and think about what you would do if you didn't have to wake up to an alarm clock every day and go to work. Where would you want to live? What would you do if you had unlimited time? Before you go too far, bear in mind that the more lavish the lifestyle you picture, the more difficult it will be to make it a reality. The more minimalist you are, the sooner you will reach financial freedom.

You should start planning your life, your goals, your objectives and then start something even if it is a small thing, work hard and set aside a specific amount of your money for savings in order to achieve financial independence. Whatever that figure is — 10%, 15% — stick to it in good and bad times. Allow it to be deducted automatically from your paycheck and deposited straight into a retirement or savings account.

●     Stage 1: Financial Solvency

If your expenses are less than your earnings, you are at this stage. At the solvent stage, you're likely to fulfil your financial obligations, such as paying bills and other withdrawals from your accounts, without actively relying on anybody else. This stage reaches us when we meet the “surviving Level”. Profit or savings result when you are able to maintain your costs below what you earn.  You may still have debts, but you're not adding any new ones and, more significantly, you can make your payments on time every month.

If you're a student, your first step toward financial stability is to get a job that will allow you to make enough money so that you won't have to rely on your parents for necessities. If you're currently generating money, reaching solvency may require taking a higher-paying job, increasing your income or reducing your spending.

●     Stage 2: Financial Stability

You can begin saving after you are able to consistently fulfil your financial responsibilities, have paid off debts and are able to keep your costs low. This additional income can act as your rainy-day fund, a financial reserve to which you can resort to when an unforeseen expenditure may arise. Normally, if you find yourself in phases 0 or 1, your only option is to borrow money, take out a loan, or fall behind on your obligations because you need to cover the emergency instead. This would not be the case if you had any money saved up.

At this point, having some large debts is totally fine and typical. You may still be paying your school loan or mortgage each month, but you've paid off the majority of your consumer debt (i.e. credit card debt) and there's no need to incur further debt.

●     Stage 3: Financially Secure

You've created enough steadiness in your spending at this stage to begin putting money aside for an emergency fund. Since you've paid off the majority of your consumer loans, the next stage is to tackle the high-interest big ones. Even settling one high-interest debt can be one less thing to worry about and become additional savings for you. This includes trying to pay off any investment debt, school loans or your car or property mortgage.

At this point, you have enough money and resources to not only survive, but to begin thriving - you are not living hand in mouth. You have financial reserves that can be used in an emergency, and you are virtually debt-free. This is when money becomes more than simply a safety net but a tool to assist you in creating a far better and more comfortable existence. You may even start putting your money to work for you by investing it.

●     Stage 4: Financial Reliability

This stage emphasises the importance of a solid investment plan. If you've been saving money regularly between stages 2 and 4, you’ll have invested part of it in solid assets that can provide short, medium, and long-term returns. You should be able to reap the advantages of your investments at this point. If your investment income is sufficient to meet your essential primary living costs, such as housing, food, utilities, and transportation, you have achieved the financial security stage.

This does not necessarily imply that you may now resign from your employment. The main premise is that if you spend $1,000 per month on living expenses, you will have more than enough savings or income from assets to pay this monthly $1,000 expenditure for the rest of your life. This does not cover expenditures for other items, such as minor luxuries, which is why you still require money from your work.

●     Stage 5: Financial Independence

Between phases 4 and 5, you continue to make money, save and invest more of it until your investment profits are sufficient to cover your existing lifestyle. This indicates that your investment income will be adequate to cover your required costs as well as additional extraneous ones for the rest of your life. This is the point at which you can declare it's acceptable to quit your work and travel the nation without worrying about your current or future costs.

There is no fixed or precise number that indicates you have attained financial freedom. Because lives differ, a simple person may claim that $20,000 is more than enough to cover all they would need every year for the rest of their life, while another person might want $50,000 or $80,000 to fulfil their basic living demands as well as the odd trip overseas.

●     Stage 6: Financial Freedom

When you are completely independent of employment, you have achieved financial independence. Simply put, your passive income must match your annual income - you are no longer dependent on your job. If you spend $75,000 per year to live your life, your passive income must be at least $75,000 per year to be financially independent. There is no such thing as a magic recipe for investing. Simply diversify your portfolio based on your time period and risk tolerance, and keep your charges to a minimum, since low fees have been shown to indicate higher performance.

You can start thinking about objectives other than your current lifestyles, such as purchases or experiences you'd want to have, and even altruistic ambitions. The most essential thing is to define these objectives and support them with your investment income. At this moment, you are truly financially free and independent in every sense of the word.

●     Stage 7 Financial Abundance

The last stage of the continuum is the moment at which you have enough for your lifestyle, both basic and luxuries, while retaining some leftover for other things. You have enough money left over from your passive income to invest in other businesses, purchase more properties, give to charities, or even establish your own.

At this point, we're talking about smart asset management, not just smart money management. How do you manage these inactive assets? How do you divide the profits from these many investments? Who are the individuals who will profit from these assets and investments in the future? How would you split or distribute them among your family and loved ones? These are all things to think about if you've achieved financial abundance.

A Forward-Thinking Approach to Financial Independence

Most individuals regard financial freedom as the ultimate goal and pay little attention to the phases that lead up to it. Financial independence becomes an illusion, an unattainable goal, a "financial unicorn" in this perspective. Because it appears to be almost too wonderful to be true, many people stop around stages 2, 3, or even 4, and never attempt to progress further.

However, by viewing financial independence as part of a continuum, the goal becomes far more attainable and practical. It also makes the journey less difficult and stressful. You don't have to get trapped or even worse, choose to stay stuck in stage 1. It's fantastic if you're able to pay off your credit card debt. Then you may focus on saving 5% of your salary this month, but attempt to increase it to 10% later in the year. You should be able to start working on paying off your school debt by next year. The idea is that every action, no matter how minor, becomes a critical stepping stone edging you closer to the opposite end of the spectrum.

These stages of financial freedom also lead you to a fundamental and necessary component of good money management: making investments. Work and money from your employment take a back seat from phases 4 - 6. You are no longer reliant on your paycheck to fund your basic expenditures and you have shifted your focus to developing and managing your investments.

Every cent saved and every debt or loan paid off is a step closer to the goals at the far end of the spectrum. Most individuals can't avoid these processes, so what's the purpose of yearning for a lottery jackpot? Take heart in the knowledge that this is your journey and that your own decisions and efforts can lead you beyond financial stumbling blocks and into smooth sailing. Gaining financial independence entails developing your talents, yourself, and your net worth. As Stephen Covey says:

“Your economic security does not lie in your job; it lies in your own power to produce — to think, to learn, to create, to adapt. That’s true financial independence. It’s not having wealth; it’s having the power to produce wealth.”