The 7 Stages of Financial Independence
Financial Independence is the idea of having enough money to decide what you do everyday on a day to day basis and not be reliant on a regular paycheck. However, if you don’t come from a lot of Generational Wealth or sell a business for a couple million dollars one day, it takes time to reach this ideal financial freedom. There are typically 7 different stages of Financial Independence but everyone’s path is different. You may be able to jump a stage or end up getting knocked back down to a lower one, or even stop before you hit the “final” stage. This is just the most realistic path for the average person to reach Financial Independence. So let’s dive in!
1) Knowing the Numbers
First stage of becoming financially independent, and the most important is what I like to call “Knowing the Numbers”. This is the stage where you simply just figure out where you are right now. You’ll add up all your expenses, income sources, debts, savings, etcetera. Essentially, you’ll make a budget and calculate your Net Worth, or your total amount of assets (savings and investments) minus your liabilities (debts). Doing this gives you two benefits;
1) You’ll know where you’re starting from. To quote Maya Angelou, “You can’t really know where you’re going until you know where you’ve been.” It’s really hard to make a plan if you don’t know where the plan is starting from and how much work you actually have to do.
2) Figure out where your money is actually going. You’d be surprised how few people actually know where their money is being spent every month. According to a report by Intuit, 65% of respondents didn’t know how much they spent the month before. As I’m sure you can assume, it’s pretty hard to give your money a job if you don’t even know where it’s being spent from month to month.
So, the first stage is “Knowing the Numbers”. Once you have an understanding of where your money is coming from and where it’s going and how much you have or owe, then you can move on to the next stage.
2) Having a Plan
Now that you know where your money is going every month, you need to Have a Plan. This is the stage where you figure out what you want and how to get there and is the second most important. Typically, you want to start making your plan by setting some Goals. Everyone’s idea of Financial Independence is different, so figure out what it means to you. You can start by looking over the different types of FIRE and see which one (or ones) align with what you want out of life. You’ve reached this stage once your plan is in place.
3) Sustainably Living
This is essentially the first stage of “being” financially independent. This is the stage where you’re able to move out of your parents home and maybe live on your own. You make your own income and pay your own bills but not too much more.
You can think of it as Paycheck to Paycheck +. By that I mean you can cover all your base expenses, with some wiggle room. In this stage, you’re living pretty cheaply and finding ways to cut back. You also have just enough extra money to either pay down debt or start an emergency fund. This is the very beginning of feeling independent but you still very much need your regular income to get by. But as you cut back and find ways to save more money and pay off debts, you move into the next stage.
4) Built the Cushion
After you’ve saved up for a while money and paid down that high interest debt, you’ll reach a stage where you’ve Built a Cushion. This is the stage where you start feeling safe. In this stage, you’ve put aside an Emergency Fund of 3 to 6 months worth of expenses and, at a minimum, have paid off All High Interest Debt (i.e. Credit Card Debt).
In this stage, if an emergency were to happen, you know you could make it. So, your car gets a flat and you need new tires all of a sudden, you have that emergency fund to fall back on. You’re no longer staying up at night worrying about bills. This is the start to getting comfortable.
5) Flexible Lifestyle
Now that you’ve been really saving for a while and living below your means, you’ve reached a level where you can start living a Flexible Lifestyle. This is the stage where you can start to take some risks. In this stage, you not only have an emergency fund and little to no debt, but you also have about 2 to 3 years worth of expenses saved up and invested.
This means you can splurge a bit. Now, if you get laid off or decide to take time off, you could travel for a while, try a new career, or maybe even start a business for yourself. You can start setting your own rules for how you want to live. However, at this stage, you can’t just stop working forever. You will become reliant on making an income again depending how you choose to use this stage.
6) Traditional FIRE
Now based on the plan you made in stage 2, your goal may not be Traditional FIRE, but this is what is typically considered the Gold Standard of Financial Independence. In Traditional FIRE, you have saved and invested 25 times your needed expenses. Thanks to the 4% Rule this means you can live off your investments forever. This is the first stage of true Financial Independence. You no longer need to rely on a paycheck at all and could chose to never work again if you wanted. This is the first stage of true freedom. Now, you could also go for different versions of FIRE, such as Lean or Fat FIRE here, but whatever version of FIRE you’re after, this is the stage where you meet it.
7) “Forget You” Money
If you’ve still been raking in the income well past Traditional FIRE, then you’ll eventually reach “Forget You” Money (but not “Forget” if you catch my drift…). This is the stage where you have so much money you literally couldn’t spend it all. If Traditional FIRE is the Gold Standard, this is the Platinum+ Standard of Financial Independence .This is like Jay-Z and Beyonce level of wealth. This is the Hundreds of Millions and some level of wealth. This is the level of Financial Independence where you can literally do whatever you want.
Now, this is, and let’s be honest here, a level most people won’t reach in Financial Independence. Typically, this isn’t even anyone’s goal. However, if you keep working and investing smartly, it’s possible you could reach this level as well. Then, who cares if you buy the latest Lamborghini or Derek Jeter’s Castle/Mansion for sale?! You can afford it!
The Wrap-Up
These are the 7 Stages of Financial Independence. Now, most people won’t typically get past Stage 4. In fact, 41% of Americans report living Paycheck to Paycheck according to a Lending Club study. If you’re goal is to make it past there and into the higher stages of Financial Independence, you’ll have to be above average. Above average in your savings and the way you cut back, the way you invest and pay attention to your money, and even the ways that you make money. The most important first step in becoming Above Average in your finances is to grow your Financial Literacy. The more you can learn and understand, the better off you’ll be. As I always say, Financial Literacy is the Number 1 Key to Financial Success! So, make sure you keep learning!
*Disclosure* This is NOT financial advice and I am NOT a Certified Financial Planner. All information is provided for educational purposes only and is not to be construed as advice. Everyone’s financial situation is different and requires individualized planning. Seek out a Certified Financial Planner for assistance with your own financial situation.
