The 7 Stages of Financial Independence help serve as a guide along the path to Financial Freedom. After learning about financial independence retire early, or FIRE, it can be hard to dive into retirement planning because you aren’t sure where to start. An easy exercise is to follow along with these stages of financial independence.
I first heard about the Seven Stages of Financial Independence on the Afford Anything Podcast with the host’s guest, Joshua Sheets – who developed the stages to help himself benchmark where he is on his financial freedom journey.
I love the stages to check your status. Most places do not have tips on how to level-up your current stage of financial independence, so I will be providing them here!
The Seven Stages of Financial Independence
Stage 0 -Financial Dependence
Everyone starts at this stage. When you are a child, you are dependent on grown-ups to provide for your well-being and financial security. People start moving out of this stage when they graduate high school or college and start working full-time in the “real-world” job market. However, not everyone who is working full-time is out of this step.
If you have massive outside credit card debt or are constantly borrowing money from family, friends, or the pay-day office, you are still financially dependent on others to take care of you.
That is okay if you are here. The post is to help you level-up out of this stage!
Tips on how to get out of Financial Dependence
1. Figure out where you are in your financial picture, your career, and spending habits. Calculate your net worth, and look at your past bills to see your spending habits. Sometimes this can be scary and a rude awakening, but it is better to wake up from the nightmare than to keep living in it.
2. Figure out where you want to go. What is your dream career? (ask yourself these questions if you are stumped). What does it mean to get a hold of your financial situation? Why do you want to better manage your finances in the first place? Is it to get out of debt, save enough money to travel the world, or help pay for your children’s college. Knowing where you want to go helps you to make the life changes needed to level-up through the stages of financial independence.
3. Cut spending. Look at what is eating your budget. Do you need to rent a cheaper apartment, go out less, or stop spending on Amazon? Cut your spending to work on becoming financially independent.
4. Work towards your dream job. Chances are, your dream job pays more than what you are doing now. Start networking, getting the certifications, and building the skills needed to excel in that role.
Stage 1 -Financial Solvency
At financial solvency, you can support yourself without help, hand-outs, or loans from others. You have payed-off all your old bills and are current on your month to month payments.
Unfortunately, many people think this is where financial planning stops. Don’t fall into the living paycheck to paycheck money trap! According to Forbes, 78% of Americans live paycheck to paycheck. Even 1 in 4 Americans making over $100,000 is still living paycheck to paycheck.
The fact that you are taking the time to look for help and are taking your financial planning seriously shows you are in the top 22% of Americans when it comes to savings! Below are some tips to help.
Tips to help get out of financial solvency:
1. Renegotiate with creditors: you still might have credit card debt at this point. Since you are in better spending habits, call your credit card providers to lower your interest. Ramit has a script on how to do this on his website.
2. Bring down your living expenses: The cheaper you live, the more you can put towards paying off debt, and the less you need to get by every day. See how the average American can save over $20,000 a year with this post here.
Stage 2 – Financial stability (six months of living expenses saved)
Financial stability means you are out of the living paycheck to paycheck and have some savings. Sadly, 39% of Americans don’t have more than $1,000 in their savings account, a study from Bankrate found. Work on increasing your savings account, while living cheaply and paying off your debt.
Tips to level-up Financial Stability
1. If you are struggling to pay-off credit card debts – pick the one with the highest interest (after getting your rate renegotiated) because that will give you the most bang for your buck when it comes to saving money.
2. OR, use the Snowballing technique where you pay off the credit card (or other sources of debt) with the lowest balance. Once that one is gone, move onto the next. Paying debt off fully gives you a sense of momentum that carries into the next debt source to be free from.
3. Take the Savings Rate Challenge. Grant Sabatier recommends increasing your savings rate by 1% every 60 days. On a $50,000 salary, that might mean saving only an extra $50 for the month. By doing this over the entire year, before you know it, you will be saving an extra $300 easily because your lifestyle will learn to accommodate the shrinking discretionary budget as you learn to save more.
Stage 3 – Debt Freedom (Free from toxic debt), and have an emergency fund
Congratulations! You are debt-free. Some people include mortgages in that definition, others do not because mortgages are usually a signal of “good debt” – for our purposes, I am going to assume you bought a home you can easily afford and pay-off or you are renting an affordable apartment!
Plus, since you no longer have debt payments, you can take that money and build an emergency fund. Typically, a solid emergency fund covers 6-months of living expenses in cash. That way, if you are fired from your job or have your life shaken-up, you can continue your current lifestyle for 6-months while you look for another way to earn income.
Steps to level up Debt freedom and your emergency fund
1. Look at your financial goals again. Remind yourself where you were and where you want to go. See how far you’ve come and celebrated your victory!
2. Look at your spending again. By now you’ve most likely optimized your savings and spending. See where else you can cut out some spending to increase your savings rate.
3. Invest more. Open a ROTH IRA, match your employer’s 401-K, and open a brokerage account. Start investing in index funds and retirement date funds (link off) to build your initial investment portfolio.
4. Research real estate. See if investing in real estate, house hacking, or renting out properties is for you.
Stage 4 – Financial Security
Financial security means you can live off the interest from your investments to cover basic, bare-bones living. Even bare-bones living will still require a significant amount of money invested in the stock market or similar investment vehicles.
At this stage – to live off of $35,000 and assuming the normal rate of return of 7%, you would still need $500,000 invested in income-generating assets.
Financial Security is the stages of financial independence where you will most likely spend a lot of your time in your financial freedom journey. Don’t get discouraged!
Tips to level-up to financial independence
1. Don’t touch your investment returns. You will still be earning a full-time salary while saving and investing money. The key is to not touch your investment returns because those compounds on your investment money to make you even more money every year.
2. Stick with it. By this point, investing might have become no longer scary and just boring. That is okay, investing isn’t supposed to be like Wolf of Wallstreet. Stick with the index funds and continue to build your portfolio.
3. Earn More money. Start working on your side hustle to earn extra income that can supplement your full-time income to make even more money.
Stage 5 – Financial independence
At financial independence, you have hit the goal of most of the people in the FIRE movement! Congratulations. Your investment income can cover your current lifestyle (at 4% with a drawl rate). Usually, that means you need 25 to 30 times your annual living expenses.
To live off $50,000 a year, that means you need about $1.25 Million in income-generating assets.
Tips to level-up to Financial Freedom
1. Do not quit your day job. If you can help it, keep working your main job. Chances are you have above a 50% savings rate by now and are earning more money from the years of honing your craft in your field. By saving more money, you can continue to invest in your chosen method of the income-generating asset while letting the interest compound on itself.
2. Keep living expenses low. It can be tempting to let your lifestyle cost creep. Make sure you are spending the money you want to be spending, not the money society tells you you need to spend.
3. Level-up your side hustle. Can you add more revenue streams to your side hustle? Could you write a book, create a course, automate, or franchise out what you’ve been doing? Leveling up your side hustle could almost be like making a second salary while still working full-time!
Stage 6 – Financial freedom
Financial freedom means you can cover your BIG Dreams and upgrade your lifestyle. You have been living frugally for probably a decade and some change now to get to having financial freedom. If you want to live off $100,000 a year – that means you need about 3 Million dollars invested. The average American household spends $73,000 – so you are living large and still saving money.
You can do all the things you’ve always wanted to do. Travel the world, buy a lake house, save for your kid’s college, and even quit your day job with little worries (as long as you are modest and spread these goals out throughout the years).
Tips to level-up to Financial Abundance
1. Keep your side hustle going. By now, your side hustle could be earning you a nice chunk of change every year. This could be used to invest or cover your annual expenses, so you don’t have to take from your portfolio.
2. Look for asymmetric risk .vs reward opportunities. You could start investigating other methods of investing such as angel investing, multi-unit rental properties, or other riskier alternative growth options. If you have the discretionary investment income, and you research the risk, these are ways several people have made millions of dollars.
3. Live the life you want. Look back on your goals when you started at level 0. How have your goals changed, and what do you want from life now?
Stage 7 – Financial Abundance
You have more than you can spend in your lifetime. Your money will easily outlive you. You can then shift your focus towards stewardship of this wealth so you can leave a beautiful legacy.
Tips to-do with your financial abundance
1. Live your life. If you are at this stage, you probably have many millions of dollars and can spend a lot without ever hurting your net worth or investment returns. Don’t fall into the lifestyle creep trap. Remember what you value in life and continue to live that way. Not the way a multi-millionaire “should live”.
2. Ask how you can help others. If you were to leave your fortune to one place, where would it go? Start asking yourself questions like this so you can contribute and help the world in the way you want to see it get better.
Main Take-Aways
1. Financial independence is a journey. There are several stages of financial independence. Learn to see where you are on it, and keep on the path towards your financial freedom.
2. Different steps require different strategies. But the basic idea is to pay off and avoid debt, live modestly, and save aggressively. Invest the difference and make your money work for you.
3. No matter what stage you find yourself, live the life you want. Not the one you feel like your net worth tells you you should live.
Action Item
Find where you are on the financial independence journey stage. Take time this next weekend to get your finances in order and see how you can work towards leveling up to the next level of financial independence.
