The 5 Stages Of Financial Independence
Let’s face it, most of us would rather be sipping margaritas on a beach than stuck doing hours of spreadsheet work. But the path to financial independence, that magical land where paychecks become optional, can feel like climbing Mount Everest in flip-flops.
Fellow financially frustrated friends, today we’ll explore the 5 stages of financial independence. Knowing the stages can be helpful (like a guide) as you try to move towards financial independence. Let’s begin.
The 5 Stages Of Financial Independence
Stage 1 – Financially Dependent
Every financial journey has to start somewhere, right? Well, for most of us, that starting line is here: you start with being financially dependent. You depend on either your parents, your partner, or even your own offspring. And it’s not exactly a fun place. When your bills are piling up like laundry on a Sunday, you know you’re in trouble.
Now, in order to progress through this stage, you need to get a lucrative job, cut back on expenses, increase savings, and eliminate debt. Additionally, you will need to craft your budget and trim unnecessary expenditures.
Hey, listen, if this is where you are, I know it’s overwhelming. But don’t panic. You can do this. Many people, millionaires included, start from this stage.
Characteristics Of The Dependent Stage
Passive Income?
None – in this stage, your income is most likely coming from a job/s (W2 income).
Savings?
Your savings, if any, is probably not very significant.
Debt?
You may have some debt. Hopefully, you don’t have a lot of debt because being financially dependent and having a lot of debt is a tough situation to be in.
Budget?
Most of the people in this stage do not have a budget. But having a clear vision of where your money is going is the first step to getting out of this stage. If you want to know where to begin, check out Budget For Financial Independence.
Retirement Account?
You might have either a 401k account or an IRA account. If you don’t, then you should. Check out this post for IRA 101.
Net Worth?
Basically zero or in the negative.
Stage 2 – Financially Solvent
Achieving solvency marks the initial step toward financial independence and is characterized by being fully capable of meeting your needs without relying on external assistance.
In this stage, your income covers all financial obligations such as bills and household expenses. While you may still carry some loans, it’s crucial not to add more. Any interest or payments associated with these loans should be manageable within your current income.
Typically, this stage entails lower expenses and higher earnings. Although your net worth may show as negative, your cash flow should remain positive, indicating a pattern of accumulating and promptly repaying debts.
Many individuals find themselves in this stage during their early adulthood, although for some, it may persist indefinitely. It’s essential to maintain motivation and persist. Implementing disciplined saving and budgeting habits can prove beneficial in this regard.
Characteristics Of The Solvent Stage
Passive Income?
No, in this stage you are still more focused on increasing your earnings through your main job/s. You could have a passive income but it is not enough to cover your expenses in any meaningful way.
Savings?
You are starting to save. But your savings ratio is likely to be less than 10% of your income.
Debt?
Either no debt or a bit of debt which you are working to minimize.
Budget?
Maybe. Maybe you have a budget. But, if you are probably not doing diligently
Retirement Account?
You probably have retirement accounts but, perhaps not very active.
Net Worth?
In the solvent stage, your net worth should be above zero.
Stage 3 – Financially Stable
This phase marks a period of financial equilibrium, bringing a welcomed sense of stability. This stage signifies a financial situation where funds are ample for both present needs and unexpected emergencies.
Paying off debts and setting up an emergency fund become top priorities, all while ensuring a steady income. By managing your financial responsibilities well, controlling expenses, and growing your savings, you are feel more secure than before.
For emergency fund, experts recommend having enough saved up to cover your living expenses for 6-8 months. This helps you stay strong financially during tough times. However, do note that while six months’ worth of savings might be okay when you’re younger, it’s wise to plan for a bigger financial safety net as you get older.
Characteristics Of The Stable Stage
Passive Income?
Maybe. You might be earning some money through passive income like rental properties or ebooks. But, it is not yet sufficient to cover 100% of your expenses.
Savings?
Your savings would be somewhere between 25 to 40% of your income.
Debt?
In this stage, it is likely that you either have very little debt or have some debt for building your assets like mortgage for a house.
Budget?
Yes, in your stable stage, you likely have a good grasp of your budget; you know how much you are earning and you are in control of your expenses.
Retirement Account?
Yes, you most likely have retirements accounts and you are actively managing them.
Net Worth?
Your net worth is well above the waters and you are building it to grow to be more than 3x your annual income.
Stage 4 – Financially Independent
This is where many people aim to be – financially independent. Through your hard work in the previous stage, you’ve saved up some money and have built a steady stream of income (hopefully multiple streams). You’ve also made smart investments that keep adding to your funds.
Financial independence means you no longer rely on W2 income to survive. If your investment/passive income is sufficient to meet your essential primary living costs, such as housing, food, utilities, and transportation, then you are now entering the FI zone.
Of course, there’s a degree to how independent you are. You may want to keep your job to be able to enjoy a more lavish lifestyle or to just keep increasing your net worth. The idea is to continue to build your passive income to go past the FI stage.
Characteristics Of The Independent Stage
Passive Income?
In this stage, you are hitting 100% of your daily expenses with your passive income. As such, you may or may not have W2 income. Working for someone just to put food on the table is now optional!
Savings?
In the independence stage, your savings ratio is 100%. Since your daily expenses are fully covered by your passive income, you can put all of your earned income to go to your savings.
Debt?
You may have some debt to finance your passive-income-generating-assets like mortgage for rental properties.
Budget?
In this stage, you are most likely to have a clear budget and be disciplined about your expenses.
Retirement Account?
Yes, you most likely will have retirement accounts and you will be diligently putting money into those accounts. This will form a lion share of your net worth.
Net Worth?
Your net worth should reach your financial independence target number. This number is usually 25x your annual expenses.
Stage 5 – Financially Abundant
Ahhh… In this stage, your passive income generates much more money than your W2 income and working as an employee is no longer a wise investment of your time.
You have enough money left over from your passive income to invest in other businesses, purchase properties, invest in funds, and give to charities. In this stage, you are probably meeting with your tax advisor a lot and thinking about how to distribute your wealth to your loved ones.
You need to stay focused and be careful with your money. It takes dedication and smart decision-making to maintain financial abundance for the long haul.
Characteristics Of The Abundant Stage
Passive Income?
Yes, your passive income is more than enough to cover your expense. You likely have left over funds to invest in more passive income generating assets.
Savings?
Yes, your savings ratio is more than 100%.
Debt?
Similar to the Independence stage, you may have debt to finance your ventures and more income generating assets.
Budget?
Most likely have a budget and discipline.
Retirement Account?
Your retirement account will have sufficient funds to cover your expenses throughout your retirement.
Net Worth?
Your net worth will last for generations.
Do you know what stage you are?
If you haven’t taken the readiness quiz yet, why don’t you take a quiz and see? Click here to take the quiz.
Ok, so if you google Financial Independence Stages, you will find various stages. Some speak of 7 stages, some 5, some 6, some 12… it’s all over the place. But, let’s keep things simple. There are many complicated things in life, identifying FI stages doesn’t have to be. Basically you are going from dependent to independent. In this regard, I think 4 is minimal (dependent – solvent – stable – independent). But, I added a 5th stage because I think it’s actually important to recognize there’s actually a stage beyond financial independence, which is financial abundance. Yeah… this is the stage beyond FI. Hope we all get there.
