As with many things in life, if you start looking behind the simplicity of a concept there is more than just a black and white division, a yes or no, a fail or succeed. Even with financial independence the reality is that you aren’t just financially independent or not… Indeed there are many different financial phases that one can reach along the way.
Below are the 8 most commonly identified stages, starting with financial dependence going all the way up to and then well past financial independence.
- Financial dependence It of course all starts with dependency. Anybody who comes into this world, relies completely on others for survival and the support of our family or carers paying for our food, housing and clothes is essential. Little by little we start moving away from this stage once we start earning our own money, becoming responsible for our own finances, even if this is a gradual transition.
- Financial solvency When you get to the solvency stage, you are able to look after your own bills and financial commitments. You no longer need the help of others to meet your financial expenses every month. You might have a debt in the form of a mortgage or student loan or even credit card loans however.
- Financial stability You get to the stability stage once you’ve been able to build up some savings and emergency money that will help you if / when you face unexpected adverse financial situations. Having that emergency money will stop you from falling back down the ladder to financial independence if something happens. It provides you with a buffer that gives you the chance to bounce back even if life deals you an unexpected card.
- Debt Freedom Reaching stage 4 might take a little longer, especially if you are not proactively paying off your debts, but once you get there, it means you no longer need to worry about monthly loan repayments, interest needing to be paid and losing money on money you once borrowed. The moment you pay off all of your loans, including your student debt, car loan, credit card debt and mortgage you enter this stage. It means you no longer owe anybody any money and that from now on you can be in full control of the money that you earn. You have no obligations to any creditors anymore.
- Financial Security To get to the financial security stage, you need to have some of your essential expenses covered by income that is not your job but a so-called passive income. This can be rental income, investments (dividends, capital gains or interest) or any other type of income stream you have created that generates enough money to cover at least some of your basic expenses, such as your utilities, food, insurance and transport costs. The more of these expenses you can cover with your other income streams, the higher your financial security. This means that your job only needs to fund your discretionary expenses from now: you only need to work for the fun stuff that you do in life!
- Financial Independence You reach financial independence once you have enough income coming in from other sources than your job to cover ALL of your current financial needs. This means that not just your basic costs are covered but also your discretionary expenses, or at least the discretionary expenses you expect to have if you decided to retire (you might be able to scale down a little). It means that you can live your current lifestyle from just your investments or other income streams, without having to rely on a job. Of course you can keep working, nobody will stop you from doing so if you want to. But the option to stop is now there.
- Financial Freedom You are financially free when your various income streams don’t just cover your current lifestyle needs but also a few luxury goals that you might have. This could be going on several long holidays and trips, buying another car or maybe even buying a small condo in the mountains.
- Financial Abundance When reaching financial abundance, your passive income has pretty much covered you for whatever you want. You’re well past the stage of covering your current lifestyle, and even those two or three things that you splurge on each year. At the financial abundance stage you’re talking about being able to do pretty much everything that you want to do whenever you want. Before you jump on me saying that you don’t want to be this “filthy” rich, remember that this doesn’t just have to be personal needs. There is nobody stopping you from setting up your own charity or supporting one or various charities to give back to the world and make it a slightly better place. You don’t have to use the money just for you..
Step 86 – The 8 Stages of Financial Independence – in detail:
- Determine at which of the 8 stages you currently are. Most likely you’ll be somewhere around stage 2 or 3 although you might already be on your way to step 4.
- Decide on your goal. Which stage do you want to get to? What will you make your financial goal to get to?
- Describe what reaching this goal looks like to you. Make it as detailed as possible and describe exactly what you would be able to do as well as what you wouldn’t need to worry about.
- For each of the stages in between your current stage and your goal stage, describe what would indicate that you have achieved it. Say you are currently in stage 3 and want to get to stage 7, then a description of stage 4 would be:
- Having paid off the $200,000 remaining principal of my mortgage;
- Having paid off $10,000 in credit card debt and student loans.
- Never having to worry about debt anymore;
- Never having to pay monthly bills on outstanding debt.
- Never losing money anymore on interest.
The 8 steps to financial independence can make you journey al little more real by applying them to your current situation and future goals. Use them to keep you motivated during your mission to financial independence! (Or to financial stability. Or freedom.. whatever you decide..)
Read more about my 100 steps mission to financial independence or simply decide to take control today and join us on our step-by-step quest on how to make your finances work for you, starting with step 1.