We used to think financial independence was a single milestone. The exact point where you transitioned from “working for money” to “money working for you.”
It’s a common misconception when people discover the FIRE movement — only focusing on the early retirement finish line.
Do realize that financial independence is a journey, not an “all or nothing” situation.
There’s a messy middle that everyone goes through before actually reaching financial independence (FI).
Better yet, I learned that as people progress through the journey, more and more freedoms become available. Every person gets to decide how fast or slow they want to move through these stages, based on how happy they are with the freedoms they have.
Stage 0: Dependence
Everyone is born here. As a baby, you are 100% dependent on your parents or other adults to survive.
Growing up (even if you have some income) you still depend on others for financial support and to cover most of your cost of living.
There’s not much freedom in this phase. Since some (or all) of your existence is supported by others, you don’t have full control of your life.
The path to financial freedom begins when your personal income can fully cover your personal expenses.
Stage 1: Solvency
The first level of independence starts when you can fully meet your financial obligations without needing help from others.
Even if you have large debts or negative net worth, you are solvent if you can cover your payments and the full cost of living.
There is very limited freedom in this phase. You are paying your own way and making your own life decisions, but if you are spending everything you earn, it feels like a treadmill.
Progress is made once you are earning more than you spend.
Stage 2: Stability
In this phase, you’ve built up a decent cash cushion for emergencies and have no consumer debt. You are earning more than your basic cost of living and have wiggle room in your budget.
Stability gives you a bit more freedom. Since you have an emergency fund, you’re able to take small risks and use your cash buffer as a safety net.
And since you’re earning more than you spend, you have the freedom to choose what to do with excess income.
Many people stop and stay in this phase, forever. They use their excess income to upgrade their lifestyle and repeat each time their income grows. This also feels like a treadmill — a faster one with each upgrade.
To progress past this phase, you need to save and invest your excess income. This is the foundation of building wealth.
Stage 3: Agency
In this stage, you’ve built up a substantial savings pile and investment portfolio.
Not only is your excess income being saved and invested, but your assets are growing and contributing to your net worth, too.
There’s a TON of freedom and flexibility in this phase. As your investment income grows, the need for personal income shrinks. This gives you more options to work and live as you please, designing your own life.
It’s important to note that “work” is still needed in this phase. You can’t fully quit working forever until you’re in the next phase when your investments are producing enough income to cover your expenses.
Stage 4: Security
This is the first phase of financial independence. It’s when your investment income can cover your basic living expenses (but not a whole lot more). “Lean FI” is what some people call this point.
You’ve reached financial freedom! And you no longer have to work to cover your basic living necessities. However, there’s no room for extra discretionary spending or personal luxuries.
When people reach financial independence (especially early in life, they typically want to travel, pursue new hobbies, share their wealth, give to charity, and treat themselves! To be able to do all this, you will want some additional wiggle room in your spending projections.
Stage 5: Independence
This stage is what most of us are all striving for. You reach true financial independence when your investment income covers your living necessities, as well as most personal luxuries. There is a cushion built into your annual budget for added flexibility.
You have reached “enough,” and the freedom here lasts forever.
It’s not uncommon for people to still have lingering “worry” feelings about money, even after FI is achieved.
The sequence of returns risk (the order in which positive or negative returns come year after year for your investment portfolio), caring for aging parents, or massive unexpected emergencies can be scary to think about.
Many people who have achieved FI still continue to work and save, which pushes them into the next phase.
Stage 6: Abundance
At this point, your investment portfolio is making more money than you need in life. The gap between what you have and what you need will continue to grow and grow naturally over time.
This stage gives you ultimate freedom. You can make all decisions in life based on happiness, not dollars.
When you’re in abundance, you’re in a great position to share, give back, help out friends and family, or set up long-lasting generational wealth.