In this post, we’ll learn about the 7 stages of financial independence. By the end, we will have a clear understanding of each stage, determine where we are at, and decide where we want to go. 

 

“It is more important to know where you are going than to get there quickly. Do not mistake activity for achievement.”

-Socrates

My Winding Road Towards Financial Independence

At a very early age, the importance of getting good grades and going to college was beaten into my head. I believed the societal belief of graduating from college, landing a good job, and I’d be successful no matter what.

 

While that does happen for some people, I’ve learned that many of us take on a much different path. It is often non-linear, filled with plenty of obstacles, and we must maneuver through many twists and turns towards our success. To be completely honest, after I graduated from college, I struggled the first few years down a winding road.

 

Unconscious Incompetence

In the beginning, I felt like I got hit with life all at once. Moving thousands of miles away, settling into my apartment, preparing for my first job, and learning how to drive in the snow… was the just the first of it. I had to learn and figure everything out on my own.

 

There is much more to life beyond college that most of us are not prepared for. We run into all sorts of obstacles immediately.

 

For me, one of the biggest challenges was personal finance. My parents never talked to me about money. I did not go out of my way to educate myself in college. Unfortunately,  I did not even know who any possible mentors to talk to.

 

In reality, I only had myself to blame for my unconscious incompetence. From taxes, student loans, debt, credit cards, budgeting, retirement, insurance, emergency saving, investing, and everything in between, I had to start from square one.

 

Mindless Robot

On my first day of work, I was given so many papers and required to return them the next day. I simply smiled and just said, “Okay!” Instantly, I felt this huge pressure that I was already supposed to be a subject matter expert on each subject. Well, I wasn’t, I was nowhere even close. So I stayed up late into the night to make sense of what all that I could.

 

The next day, I returned the papers with a lot of empty spaces. I mustered up the courage to ask for advice from a 50-year-old HR person and a 35-year-old personal finance advisor to help fill out the rest. Both individuals  I had never meet, were in different age ranges, had families, and did not know anything about my situation.

 

They gave me a brief description of everything. I shook my head as if I understood everything in one go. Honestly, I just checked whatever boxes they told me to check and signed my name on the dotted lines. I was no better than a mindless robot.

 

Back to Square One

So off went the papers and one less thing to worry about. Or so I thought. I quickly learned that if you don’t take the time to deal with your problems, they never truly go away. The problem will always make their way back and sometimes it is much worse.

 

There was a ton of information to learn and it all piled up quickly. I did my best to juggle it all on top of all my other daily expectations. On the inside, I was stressed out beyond belief. But I knew that I needed to take the time to learn about each subject.

 

It was hard to see the light when I was in the trenches, in the thick of the chaos and madness. But just like the changing of the seasons, at the end of every bleak winter there always comes a beautiful spring. With time, I was able to understand and make the best decisions for the life that I want to live.

 

The Journey Continues

Slow and steady, I studied and researched each subject. Only then, I was able to see all the mistakes I had made. Most importantly, I stopped putting my blind faith in others and allowing anyone else to determine my future. In time, I built up the confidence to determine my own.

 

While I feel as if I have a handle on some things, I’m still in the process of figuring out a lot more things. My journey continues to unfold through its many twists and turns. I know that I will still make plenty of mistakes and continue to use each opportunity to learn as I go.

 

We all have the freedom to learn and the power to apply our knowledge. In time, we can hone in on our finances and build a life that we love. A big part of it is being aware of all the opportunities and knowing where we are starting.

 

7 Stages of Financial Independence

We are all on a journey in life and that includes a financial journey as well. A fundamental part of the path is knowing about the major milestones, figuring out where we are, and determining what is needed to reach the next point.

 

There are plenty of opinions and viewpoints on the actual number of stages to wealth and there definitions. A majority of them range from 3-11 stages. I’ll share one from Richard Glunt, on Moneywise.com, The 7 Stages of Financial Independence: What Stage Are You In? as a happy medium and that is prominent in the personal finance world.

 

• Stage 0: Total Financial Dependence
• Stage 1: Financial Solvency
• Stage 2: Financial Stability
• Stage 3: Debt Freedom – Crossover point, red to black
• Stage 4: Financial Security
• Stage 5: Financial Independence
• Stage 6: Financial Freedom
• Stage 7: Financial Abundance

 

Stage 0: Total Financial Dependence

Everyone starts at this stage from the moment they are born. We all had to depend on our parents for some time for our survival. Once we enter the full responsibilities of adulthood, we can still be considered in the financial dependence stage if we have to depend on someone or something to cover any expenses that we cannot pay for.

 

Some examples are living above our means (we spend more money than we earn), we have to borrow money from family or friends, we take out a loan from the bank, or are forced to take a payday loan. Essentially, we are in this stage anytime debt payments are greater than our income.

 

Stage 1: Financial Solvency

The next three stages are what some consider different levels of the “surviving” stages, financial solvency being the first. We enter this stage once we begin to earn a profit, expenses do not exceed income, and we are not taking on any more consumer debt (i.e. credit card debt, auto loans, mortgages, payday loans).

 

Here we are no longer dependent on an outside source to provide for us at all. We can meet all our financial commitments such as being current on all bills and meeting our monthly minimum payment on student loans, mortgages, etc. In other words, we are living within our means.

 

Stage 2: Financial Stability

The next stage is financial stability and it is such an important stage that can make a big difference in many of our lives. During this stage, we have repaid all of our consumer debt and finally able to start the savings process.

 

We may still have “good debt” (student loans or mortgage) but we can cover the monthly minimum payments. In my opinion, good debt or bad debt, debt is debt and debt is the devil in disguise. So keep in mind that it is still best practice to pay these down as quickly as we can to lessen the blow of the accumulated interest that is not in our favor.

 

Building a Buffer

This is where we begin to create a buffer that prevents us from having to depend on others, gets us out of the vicious debt cycle, and opens up space for us to have options. We often hear this referred to as a rainy day fund, emergency fund, and my personal favorite, the fuck-off fund.

 

According to an article on CNBC.com, an alarming 60% of adults in the U.S. would not be “able to cover an unexpected $1,000 expense, such as an emergency room visit or car repair.” That means that so many of us are living paycheck to paycheck with exactly $0 in our emergency savings fund.

 

Once the unexpected arises (spoiler alert, unexpected expenses ALWAYS show up), many of us would be forced to charge it on a credit card or take out a payday loan. Both scenarios require taking on more consumer debt, which comes with exuberant interest rates. This throws us right back into the debt cycle, making it sometimes even worse.

 

Create Space for Options

Dave Ramsey, a well-known personal finance expert, suggests having an emergency saving of $10,000 that is easily accessible within 24 hours. With a cushion that large, it would prevent us from going back into debt by having to take out a payday loan or charge it on a credit card. In theory, we would not fall behind on current bills because we had enough cash to pay for an emergency expense.

 

$10,000 may be a stretch for some people right now, but even an emergency savings cushion of $1,000 could dramatically impact the financial outcome for most people in the U.S. Begin by taking baby steps and build up to $1,000. Once that mini-milestone has been hit, work towards increasing the buffer to $10,000 or 3-6 months of major basic living expenses (housing, utilities, transportation, food).

 

It’s Okay to Start Small

Like I had mentioned before, a buffer creates room for options. With $1,000 saved, it could be the saving grace that prevents us from drowning deeper into debt. As we build a bigger buffer, such as $10,000 or 3-6 months of living expenses, it could provide the option of leaving a job we hate to find one that is not only better suited for us but starts to improve our quality of life as well.

 

I plan to write a post with various ways to effortlessly save $1,000 for an emergency fund but not sure when I’ll get around to it. If you need help or ideas, feel free to comment below or shoot me an email so I can at least point you in the right direction or find someone who can!

 

Stage 3: Debt Freedom

Debt Freedom is the last of the “surviving” stages. We enter into this point when we have paid off all of our debts, including good debts such as student loans and mortgages.

 

This is referenced as the “crossover point” or going from “red to black.” Essentially it means that we have finally broken even. We are no longer living paycheck-to-paycheck, not accumulating additional debt, or spending more than we earn.

 

Value of Money

Typically, the way people view money at this stage begins to change. The value of money is no longer a safety net. More options open up and the possibilities start to become limitless. Our choices begin to reflect ways to improve our overall quality of life.

 

For instance, instead of maintaining a job we hate to survive, we have the flexibility to explore new career options. We can free up valuable time by outsourcing tasks that we had to spend energy figuring out because could not previously afford it.

 

Money Does Not Equal Happiness

It is important to remember that money does not equal happiness, but in the stages leading up to debt freedom, it does help to create a much more comfortable life. With all the new lifestyle upgrades, we will feel emotions of happiness up to a certain point when it all becomes normal.

 

Hedonic adaption sets in and the things that once brought you happiness merely blend in with the background. We hear plenty of stories of well off people and families, but deep down inside they are no happier than anyone else. “It is not money that lies at the root of all evil; it is the lack of money.” –Brian Tracy

 

Money is a Tool

Money does not make one immune to feelings of depression, emptiness, or lack of purpose. These emotions can happen to anyone. It is best to think of money only as a tool to help build a life you love with the people and experiences that you truly care about.

 

Freedom from debt, having a well-funded emergency savings fund, and living within our means puts us in a completely different place. We move from simply trying to survive in life and begin the journey to thrive.

Stage 4: Financial Security

As we transition out of the “surviving” stage and into the “thriving” stage, the next major financial milestone would be financial security. This stage involves having an income from our investments that can cover our basic necessities for the rest of our life. We would be able to afford the basic costs of housing, food, transportation, etc. each month.   We can build up investment income at any time since there are no barriers to entry. It is possible to build investment income even if we have debt. Investment income can come from many different sources such as real estate, businesses, retirement accounts, etc.   Most of us start when we set aside money and invest in a 401K with an employer. Time is a valuable asset. It is important to understand that time + money can work against you (debt interest), or work for you (compound interest). It is up to each of us to figure out our situation and determine what makes the most sense, pay off debt or start saving/investing.  

Seek Out Financial Help

It may be helpful to seek out the expertise of a financial advisor or financial planner with a fiduciary duty. They can help us to understand any loose end or provide feedback that could save us a lot of money in the long run.   Do not be afraid to shop around until you find one that you are comfortable with. Do your research and come prepared with questions to help determine who will be a good fit for you. It may take a few tries until you find someone who understands and sees the same vision for your future as you.   Again, they are only advisors that will provide suggestions. They do not have a crystal ball that will see into the future. In the end, we are the only ones responsible for our decisions and what we do with our money. So make sure to ask questions for clarity and do not feel pressured to do anything that you do not want to.  

Stage 5: Financial Independence

Once we have our basic necessities covered through investment income, being able to cover our current lifestyle for the rest of our lives would be considered financial independence.   It means that we have enough investment income coming in to cover all basic living expenses plus our current lifestyle each month. No set dollar amount signifies that we have reached financial independence. It is because this number is different for every single one of us.   For instance, a single individual may be able to live off of $30,000 a year for the rest of their life. While another single individual may need $100,000 a year to continue to live their current lifestyle. Housing, family, vacations, geo arbitrage, etc. will all have an impact on what the number could be.  

F.I.R.E. Movement

This is where most people consider having a job as optional. They choose to work because they want to not because they necessarily have to. It has been referred to as F.I.R.E., Financial Independence, Retire Early, a term that has become very popular and describes this milestone in-depth fairly well.   If you would like more information, check out:

• Money Mustache (Blog/Website)
• Mad FIentiest (Blog/Website/Podcast)
• Choose FI (Blog/Website/Podcast), their essential listening list here
• Your Money, Your Life – Vicky Robins (Book)
• A Simple Path to Wealth – J. D. Collins (Book)

 

Stage 6: Financial Freedom

Once investment income provides more than enough security to cover basic living expenses plus our current lifestyle for the rest of our lives, the extra investment income secures financial freedom.   We can use this time as an opportunity to pursue other passions, experiences, opportunities, and lifestyles. Ultimately, we have more freedom to take even greater risk than before and to do things based on want instead of need. Our goals and dreams are fully funded by investment income and not an outside source.   

Stage 7: Financial Abundance

The final stage of the financial journey leads us to financial abundance. In this milestone, we have more than enough to cover the comforts for the rest of our lives. We have built a buffer to live comfortably and have the complete freedom to do what we want.   In this stage, the options are endless: from sharing our wealth, traveling the world, building business empires, buying real estate, start/donate to charity, or indulge in luxury. With so much freedom and power, the focus shifts on how to appropriately manage the surplus.  

Smart Asset Management

Instead of concentrating on smart money management, we direct our attention to smart asset management. This is said to be one of the most challenging stages of all. Richard Glunt points out a few great starting questions in his article to help get us aligned:  

• How do you control these passive assets?
• How do you allocate the income from these different investments?
• Who are the people who will benefit from these assets and investments at a later time?
• How will they be divided or distributed to your family and loved ones?

 

Journey To Financial Independence:

Once we have clearly defined where we are, we must also clearly define where we want to go. Only then, we can work towards our financial plans and put systems in place to achieve our goals. We are all capable of creating and living a life that we love.

 

Life is Not a Race

Love this quote I recently saw from Jay Shetty, “Life is not a race. You don’t start in the same position and everyone isn’t going in the same direction. You have your own space, your own pace, and your own place you want to get to.”

 

Remember that it’s a journey, not a destination. Everyone’s journey is different, non-linear, and their own. There may be times when we shift backward or bounce in-between stages. It is all perfectly fine. Life happens and will continue to happen. Just remember to keep moving forward!

 

Let’s Talk About It:

Where are you at on the financial journey?

What stage will you reach next?

What life-long stage are you working to achieve?

 

Leave a comment below or shoot me an email at connect@howdyace.com. If you found this information helpful and know someone who could benefit, don’t hesitate to let him or her know and share this post with them!

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Thank you so much for sharing your time and energy with me!