Navigating the 3 Stages of Financial Independence
November 08, 2021
There are 3 stages of financial independence, here’s how to reach them.
You’ve probably heard the term “financial independence” at some point, but what does it actually mean?
More importantly, here is why it’s important, and how you can achieve it.
Your Financial Independence Roadmap
Broadly speaking, financial independence means you don’t have to rely on others – or a paycheck – to meet your life goals. After you set out on your own, the meaning typically changes as you progress through life.
There are three major stages of financial independence:
1. Making your first budget and learning how to meet all your monthly bills (with mistakes along the way).
2. Having enough savings for common emergencies.
3. No longer needing to work.
Moving from stage one to stage three isn’t easy. It requires at least some financial discipline and sacrifices. Here’s more about the three stages, and how to manage a successful journey through them.
Stage One: Moving Out
Do you remember your first job? Getting your first paycheck was a major source of pride and accomplishment. This leads to your next major milestone—being able to afford to move into your own place.
It’s not unusual to get a little monthly financial assistance, whether from parents, governmental aid or other means.
Stage One Milestone: Living Within Your Means
Once you can pay for all your expected monthly bills, you’ve reached the first stage! This is a major accomplishment and includes everything from rent, utilities, food, car payments, and medical bills.
However, a major financial bill or disaster can easily derail you, so hopefully, you have someone you can borrow money from when trouble happens—because it will eventually happen.
Work to Avoid Living From Paycheck to Paycheck
Sadly, the first stage may also include living paycheck to paycheck. In too many cases, this financial cycle is hard to escape, pulling those trying to struggle out of it back in.
80% of American workers are stuck in this stage – including one in ten Americans making over $100,000 annually! Saving is your one-way ticket out of this cycle.
Stage Two: Building Your Savings Account
Life is going to throw you some curveballs. Ironically, you must learn to expect the financial unexpected. Cars and homes sometimes need repairs, medical expenses often come out of nowhere, and jobs today are much less certain.
If you expect to be fully financially independent, you need to start saving money consistently.
Aim to Generate Extra Income and Save Money
This usually involves reducing spending, and may even require generating extra income. You can pick up a part-time job or work as a freelancer online. You’ll have to make a budget and if you’re having trouble saving money, you’ll need to track every cent you spend.
Eliminate Bad Debt, Too
A major way to reduce your spending is to pay down debt first. Anything extra you can pay on your credit card balance each month goes directly to the principle, which saves you interest.
If you can cut out one latte or one restaurant meal each week, that savings can help eliminate your monthly credit card payments over the long term. Paying off debt (especially high-interest rate debt) can free up additional cash every month, which you can save or even invest. Small changes to today’s spending now have a big financial impact later.
Start By Working Toward $1,000 in your Savings Account
After reaching stage one, your first step towards stage two should be to keep at least $1,000 in the bank at all times. Not even 4 out of 10 Americans have this, leaving them just one big bill or missed paycheck away from potential disaster. Once you’ve hit this number, you can aim to build your emergency fund.
Stage Two Milestone: Build Your Emergency Fund
However, to fully reach stage two success, you need to save around 6 months’ salary. The money in your bank savings account will be insured against loss (FDIC insurance goes as high as $250,000) and is always immediately available.
Any money you can save beyond this should be put into investments. But investing money is no substitute for an emergency savings account! Aim to have both investments and savings, but build up your emergency savings first.
Stage Three: Reaching Financial Freedom
Ultimately, financial independence means freedom from ever having to produce money from a full-time job again. Your income will come from mostly income-generating assets that will pay you automatically.
Stage Three Milestone: A Fully Invested, Income-Generating Portfolio
Unless you expect a 7-figure benefit (such as from a trust fund or will) or a massive salary in your future, you’re going to have to follow a budget, save, and invest your money. This includes not only starting a savings account but also building a portfolio of diversified investments and retirement savings.
Your Lifestyle Determines How Much You Need
How much should you save? It depends on what lifestyle you want and expect after retirement. The more you’re looking to spend each month in retirement, the more you’ll need to save and invest beforehand.
Remember, even if you’re healthy in retirement and plan on working after reaching stage three, your potential income should be seen as extra, not essential.
Congratulations! You’ve Reached Financial Independence!
Through a combination of hard work, discipline, and luck, you now have enough passive income to (hopefully) last you the rest of your life.
However, this is not always the end of your career! Many who achieve full financial independence choose to continue working. The right job can actually help you live longer!
You Can Still Work if You Want
However, the difference between being forced to keep working, and doing so by choice is like night and day. Once you’re fully independent, you may look to new, more desirable ways to produce income, including exploring if your hobbies can be leveraged for revenue generation or consulting as an expert in your former field. Some also use this opportunity to start businesses they always wanted to try.
Which stage are you at? What does it mean to be financially independent to you? If you invest some planning and make small sacrifices, you can navigate all three stages and enjoy your retirement.
Flyp is Your Advocate
Flyp is dedicated to helping you thrive as you pass through the stages with sound financial advice and a commitment to empower those who are traditionally exploited by banks. Join our waitlist to learn more.