In order to understand what Financial Independence refers to, we need to see first what are the financial stages a family or person can be at. In our research for this article, we’ve found two major different classifications. After thoughtful consideration we have decided it would be best to present them both as they are not contradictory but rather complementary and they look at the same topic from different angles.
Seven Stages of Financial Independence
A more formal classification for the financial stages a person or family can be at is the more general one that we can find in most financial related literature, in a similar or slightly changed form from the following:
Stage 1 – Total Financial Dependence
This stage is for the ones that earn less than they spend or they don’t earn at all. If you rely on your parents or other kind of monetary assistance, you are in this stage.
This is the best place to start planning to change your life and start thinking about what life would be if you would have financial freedom. You can start saving a specific amount of money regularly. Even if the amounts are not big or might seem insignificant, this exercise of saving from the start can help a lot in the long run as you practice and get used to saving and building wealth.
Stage 2 – Financial Solvency
When you start earning more than what you spend, you are at this stage. At the solvent stage you are fulfilling your financial obligations, bills and withdrawals from your accounts without relying on somebody else. This is the “surviving level”. By maintaining your costs below your earnings, you begin accumulating profits or savings. If you are able to make your payments every month on time, and you don’t add new debt, this is the point where you can start acting about moving to the next stages.
If you’re a student, the first step to moving onto higher stages is to get a job (or even a 2nd one) that will make you enough money so that you no longer rely on assistance. If you’re already earning money, and you cannot cover your expenses, you may require increasing your income or reducing your spending.
For this stage and the previous one it is important to live by a key principle: “don’t buy things with money you don’t have”, this means you shouldn’t get a loan to upgrade your car, or to buy the newest gadget just because there is hype about the latest gimmick. It would benefit you more in life to adapt and find ways to live frugally.
Stage 3 – Financial Stability
Here is where you are at when you are able to consistently fulfill your financial responsibilities, have paid off high interest debts and are able to keep costs low. At this point you can increase your savings or begin if you haven’t started saving already. These savings can act as your emergency fund, an amount of money that you can resort to when unexpected expenses arise. This fund is your safety net, so you won’t fall back down to lower levels.
At this point, having long term debt is fine and typical. Even if you are still paying mortgage or school loans, as long as you are confident you will be able to meet those expenses and won’t have to acquire new consumer debt, you are ready to move to the next stage. We are not saying that we recommend you go get a mortgage or a lease for buying a new or used car. We are saying that you shouldn’t beat yourself too much about having debt you acquired earlier in life. As we mentioned, as long as you are able to meet those expenses regularly over a long period of time, you can look forward into moving to the next stage.
Stage 4 – Financially Secure
By now you might have a generous emergency fund consisting of several months of expected spending 3 months, 6 or maybe a year. Now it’ a good idea to start paying high-interest loans. Especially if the interest of that loan is greater than the potential return you would get from investing it is a good idea to pay off the debt first before investing. We will get more into detail in following articles on how a person can do this.
At this point, you have enough resources to prosper. You have an emergency fund and are virtually debt-free (meaning no consumer debt like credit for a new washing dish or holidays). This is when money becomes more than a safety net, at this point money can start working for you by investing it.
Stage 5 – Financial Reliability
You have reached this point when your investment income is sufficient to meet your essential primary living costs, such as housing, food, utilities and transportation. This doesn’t necessarily mean that you should hand your resignation letter to your employer. The main idea is that all your NEEDS are being paid off with income from your investments for the rest of your life. This does not cover expenses for WANTS such as vacations, minor luxuries, for these you are still supposed to work or build ways to generate other income streams.
Stage 6 – Financial Independence
You reach this point when you continue to make money, save and invest more of it until your profits are enough to cover your existing lifestyle. This means that your investment income is enough to cover both your NEEDS and WANTS for the rest of your life. This is when you can declare that you have what’s called “FU money”. The ability to say the proverbial “FU” to whoever and whenever you are asked to do something you don’t feel like and go travel your country. You can keep working at this point if you want to consolidate your position
As we already know, bearing in mind that wealth is subjective to each individual, there is no precise number that indicates you have attained financial freedom. Because lives differ, for a person 20000$ would be more than enough to cover all their yearly expenses while for another 75000$ might not be enough.
Stage 7 – Financial Abundance
This is the last stage. Here you have enough for your lifestyle, basic needs and luxuries are covered from your passive income, and you still have some for other things such as charities or other financial ventures.
At this point you are thinking about asset management and planning how to pass your wealth to the next generations or how to give to charities or maybe establish your own.
The next classification we’re looking at is a broader one, and it looks at financial status on a general worldwide level. It can help us determine for ourselves where we are financially when compared to the rest of the world.
Five financial status layers
We’ve found this classification best depicted in a twitter thread posted by the user @punk6529:
Level 1 – Crushed by Circumstances
This is the level of the most unfortunate amongst the people from the entire planet like people suffering from natural calamities or war destruction. People on this level are constantly struggling with securing basic survival needs such as food or shelter.
Level 2 – The Struggle is Real
The second level refers to people that are struggling with financial problems from month to month. Individuals or families in this category are usually in good health but with no savings, unable to cover an unpredicted expense.
Level 3 – “Middle Class”
Owning a house, a car, having some savings and worrying about big future expenses but knowing that you will be able to cover them are the criteria to put you into this layer. By historical and global standards you are already in the 1% of anyone who ever lived.
Level 4 – We Like Nice Things
As @punk6529 puts it “This is the vast and endless consumerist playground”. This is the place where we can afford mostly anything that we want to buy. It is the point where we have to figure for ourselves how the level of happiness we get from buying all this new stuff correlates to this financial level.
Level 5 – Post Consumption / Self-Actualization
This fifth level is related to one’s mindset rather than the financial level. The consumption needs are met by the previous level already. At this point, one person no longer wants “stuff”. People at this level compete for abstract goals, usually bigger than one individual. People at this level work for internal motivation, not for external one.
Although we have summarized here this classification, we strongly recommend you check the entire thread from Twitter user @punk6529 as it is quite insightful and also offers some great advice on how to advance to certain levels: