Long term financial goals can sometimes seem so big that they feel almost unattainable. especially, when we’re just getting started on our own roads to financial Independence. I and many others like me in the financially independent retire early community has found it helpful to break down the goal of becoming financially independent into smaller and more manageable levels of financial Independence. It makes it easier for us to track our progress which in turn helps us to stay more motivated throughout the whole process. also, because it helps us to get over the initial hurdle of starting to chip away at this mountain of a task.
Today I’m going to be taking you through what I consider to be the ten levels of financial Independence, as well as, give you an example on how to go from the first level to the top-level in your lifetime.
Now obviously these ideas of the levels of financial Independence are not solely my own. They are also not new as they have been many articles and blog posts that have covered this topic already and have done so for many years. Consider this a summary of many of the ideas proposed in those articles and a few of my own. If you want to learn more about the topic feel free to check out some of the articles in the blogs HERE.
Let’s get started. So real quick, the ten levels of financial Independence according to me anyway are.
- Level 1 Financial Dependence
- Level 2 Financial Solvency
- Level 3 finance Stability
- Level 4. Debt Freedom
- Level 5 coasting FI
- Level 6 Financial Security
- Level 7 Financial Flexibility
- Level 8 Financial Independence
- Level 9 Financial Freedom
- Level 10 Financial abundance
The definitions vary a little bit depending on what article you’re reading but the levels are usually defined as something like this
Level 1 – Financial dependency is when your debt payments and other living expenses are greater than your own income. This means that in one way or another you’re dependent on someone or something else to help you pay for all your bills. If you happen to be a kid and don’t actually have any bills you may need someone else, usually your parents to pay to put food on the table, keep the lights on and have a roof over your head. This is the level that starts out on that referred to as a level 1 because as a financial dependent you obviously don’t have any Financial independence.
Level 2 – Financial solvency is where your current on all your debt payment and you can meet your financial commitments and other living expenses without any outside help.
Level 3 – Financial stability is usually defined as when you have built some sort of emergency fund in addition to being financially solvent.
Level 4 – Is debt freedom and it’s defined differently depending on whom you ask. For some, it’s being completely debt-free mortgage and everything. For others, it’s being just free of the high interest like credit cards although, you still may have a mortgage or some other debts like student loans. For others, it’s paying off all your debts except for your mortgage but your credit cards, student loans, car loans, and all that stuff is paid off.
Level 5 – Is known by several different names. The main one that I’ve seen is coasting Financial Independence but sometimes it’s also known as freedom from an employer or Barista Financial Independence or agency depending on the Blogger looking at. I personally like the idea of it being coasting Financial Independence so that’s what I’m going to be using in this article. Know that some people refer to it by one of the other titles but the idea has the same. You reach the level of coasting Financial Independence when you could if you wanted to step down from a job that maybe higher-paying but also be either less satisfying or more stressful or both. Into a new job that may be lower paying but more enjoyable or less stressful or both.
This is because in the early years of their career or just the most recent years of their career someone who has achieved this level of financial independence has managed to save a very decent sum of money. That would be able to provide for the later years of their retirement after it has grown even if they don’t put any more money in. Therefor all this person would need to do is make enough money to get to age 60 or 65 or 70 or whatever the numbers work out to be for them when they’re going to start withdrawing the money from their Investments. In a sense, a person who achieves this level of financial Independence worked really really hard and was very frugal usually in the first few years of their career. That way they could Coast their way into retirement.
Level 6 – Financial security is effectively when your cash flow from your Investments has grown large enough that it can provide for your annual basic survival expenses. I say survival expenses because I do differentiate that from living expenses. Survival expenses are just the basic things you need to survive. Food, water, shelter, some form of transportation, clothing and probably insurance. Basically, this does not include things like Netflix subscriptions, cable bills or heck even the internet. It is purely survival expenses, so this probably isn’t the ideal spot to retire and I certainly wouldn’t want to retire at this point. It is an important level to keep in mind because it does give you security, hence the name. If you were on level six and got fired today you will be okay, you can survive until you found another job. This is essentially the first level that really gives you the peace of mind even if the lifestyle, should you have chosen to live it, may not be the most lavish.
Level 7 – Financial flexibility is similar in many ways to Financial Security just step up. Its when you have the ability to live off your current cash flow from your wealth assuming that you have a flexible spending plan that adjusts for up and down markets. If the markets up 20% one year you may be able to spend a little bit more but if the markets down 20% the next year than you’re not going to spend quite as much. I’ve seen it find many ways so it could vary depending on whom you ask but the one that I personally like the most like my own kind of guidepost. It’s roughly half of full Financial Independence which, if you’re following the 4% rule is going to be roughly 12 and 1/2 * your current expenses have been saved. so not quite financial independence but getting there.
Level 8 – Is financial Independence and it’s usually based off the 4% rule. You can follow the 4% rule when you have saved roughly 25 times your annual expenses the vast majority of the time this amount of money will be enough to allow you to maintain your current lifestyle in retirement. As a result, you could be considered financially independent. Some articles end it right there. I think there are a couple of levels that are a bit higher on the totem pole. than just Financial Independence that is worth considering. Even if not all of us are going to try to achieve them because being at level 7 allows us to do what we wanted all along. Lets briefly talk about those other levels.
Level 9 – Is financial freedom which I’ve often seen to find us the cash flow from your Investments being greater than financial Independence and a few more life goals that you have. Life goals, of course, will differ for everybody. This could be something like taking a trip overseas or moving to a new place you’ve always wanted to live but haven’t had quite enough money to live there up until now. Whatever the case may be for you. It’s different for everybody, you’re going to know your own dreams better than I will.
Level 10 – Financial abundance. This one is quite simply that the cash flow from your investments is far more than you will need. You could spend it if you really wanted to but it would actually take some effort and the stuff from level nine doesn’t really cut into it much at all. You could up those goals even more and still have some cash flow left over at the end of the year. this also has a slightly different definition for each person depending on whom you ask but I personally like to think of it is roughly three times your financial freedom number. This would allow you experience a horrible bear Market where your Investments drop down by 50% in a year and you would still have one point five times the amount that you would need to maintain the lifestyle you lead in level 9. To me, that means that it’s probably more than you’re ever going to need but again that’s strictly my own opinion on the matter.
Those are the 10 levels of financial Independence. Now let’s walk through a hypothetical example of how someone could go from Level 1 being financially independent in a single lifetime.
John and Jane are recently married couple each making $20 an hour at the age of 23 or $83,200 a year assuming no overtime, which is pretty good. They manage this because they are not only good hard-working people but also got good grades in school and we’re selective about the jobs they decided to pursue. Obviously, just like everyone else they would have started off as financial dependence. Possibly while going to college they may have been building up some student loans that they wouldn’t have had the money to pay off at the time.
Assuming of course that they didn’t earn enough money in school to keep up with that Rising debt. For the sake of this example, that’s what I’m going to assume. In all, they have credit card debt, two car payment and student loans which have balances of $5,000, $35,000 and $60,000 respectively.
Since they got their jobs they are no longer financially dependent and their incomes have allowed them to become current on all their debt payments without the help of others. In addition to their regular monthly debt payments, their annual expenses are $48,000 a year. They are currently in level 2 Financial solvency and they’re trying to figure out a way to move to level 3 Financial stability. In order to do that they need to figure out a way to build up an emergency fund.
If they were following the 10 levels to a tea then they would look to build a 3 to 6-month emergency fund of their survival expenses. However, this is not the only way to approach it. If you were following the Dave Ramsey 7 baby steps you would start off with just $1,000 starter emergency fund and then get right onto attacking your debts. Other financial systems and plan may have you approached it entirely differently. Either way is perfectly fine because the 10 level system isn’t really meant to be a financial formula. It’s more there to give us some sort of a guidepost so that we can better track our progress towards achieving Financial Independence.
Just for the purposes of this article, I am going to assume that they follow the 10 levels in order. so, we are going to be building up a full emergency fund. In order to find out how much of an emergency fund they will need you will need to know how much money they need to survive. Not necessarily on their current level of expenses while they have jobs but purely on Survival expenses. They are basically the four walls of your financial house or in other words again food shelter utilities basic clothing some form of transportation and Insurance.
I’m going to assume that their survival expenses are right around $3,000 a month. This means that in order to get a three-month emergency fund they would need $9,000. To get a 6-month emergency fund they would need to save $18,000. Both John and Jane feel pretty secure in their jobs and the markets doing fairly well. So, they don’t think it’s too likely, at least in the near-term, that they would have to get laid off when the company decides to downsize.
They decide together that they are comfortable for now with having just a three-month emergency fund of $9,000. With $83,200 income and $48,000 a year in expenses. Plus, minimum payments of $100 on the credit card which is 2% of the balance. $550.78 on the car loans and $621.83 on the student loans. They will have approximately $1,660 a month left to start building their emergency fund. However, both John and Jane have been looking into their finances and researching a lot lately. They became fired up at the possibility of becoming financially independent while they’re still young. They wanted to see if there’s a way that they can speed up this whole process. As it turns out thankfully there are many.
After taking a look at some of the options they decided that they’re going to work as much overtime as they possibly can. For the sake of Simplicity, I’m going to assume that they managed to work on average five hours per week of overtime. That will increase their monthly income for about 1300 a month. This means that instead of $1,660 a month they will have about $2,960 a month left over after expenses. They’re going to sell both of their cars and buy some nice used cars with cash to help knock down some of that initial debt. After putting out a couple of ads online they managed to find buyers for each of their cars. The buyers were willing to give them $15,000 each. They take that $30,000 and you was $5000 to pay off that credit card balance. Another $10,000 was used to buy a couple of used cars from someone that they know takes good care of their vehicles. That maybe be a family friend mechanic that they trust. The remaining $15,000 is thrown at their car loans. This means that the credit card loan is fully paid off and therefore $100 minimum payment is no longer needed. John and Jane start throwing $3,060 a month which is what they have left over from their credit card payment into their emergency fund and they get it fully funded in just under three months. Over the course of those first three months, they managed to bring their car loan balance is down to about $18,400. Thanks in large part to the $15,000 that they threw at it right at the beginning after selling their cars. Also while making the payments in those first three months.
Now that they’re emergency fund is fully funded they’re able to throw that $3,060 a month in addition to the $550 a month minimum payment that they were already making their car loan. They get it wiped out in six months flat. A mere nine months into their journey John and Jane not only have a fully funded emergency fund. They also have paid off both of their car loans. Now there’s just the student loan tackle. Thanks to the fact that they’ve been making minimum payments on them for 9 months. Plus, the fact that they have a little over $3,000 at the end of the ninth month left over after paying off their car loans. Their student loans now have a balance of $53,263. John and Jane follow the same pattern that they didn’t their car loans throwing everything they’ve got left over after it’s which is now over $3,600 a month. Since they no longer have a $550 car payment to make. They pay off their student loan in full in 13 months.
John and Jane have managed to be debt-free and have a fully funded emergency fund in 22 months or just under 2 years. They have now officially reached level 4 and because of that they now have over $4,200 a month left over after expenses. They can use to get started investing. Which brings us to level five Coasting Financial Independence.
Let’s assume that John and Jane want to retire by the age of 65. That means that whatever they put in now needs to be enough to grow to a point where it can support their lifestyle in retirement by the time they’re 65. If we assume that an average rate of return on the market is about 10% before inflation. An average inflation rate is about 3% per year on average then we can get a rough estimate of how much John and Jane need to put away in order to achieve a state of coasting Financial Independence. In this particular hypothetical example since they’re 24 and almost twenty-five they will have somewhere in the neighborhood of forty years to let that money grow before needing to take any of it out. If their expenses were about $48,000 a year at the age of 23 then 42 years later when they’re 65, assuming a 3% rate of inflation, they would need a tad bit over $166,000 each year to live on.
Assuming we follow the 4% rule to figure out how much they need once they fully retire to be financially independent. That means that they would need to have at least 4.15 million dollars invested in the market by the time they turn 65. This means in their particular case they would need roughly $110,000 saved up, give or take, assuming a 10% rate of return like we said in order to achieve coasting Financial Independence. They’re now able to save about $4,233 a month now that they’re debt-free they’re able to hit that goal in 2 years flat. That means, in theory, they would be able to step down from their current jobs and move more rewarding less stressful but probably lower-paying jobs. This is just three years and 10 months into their financial Journey. That is incredible! Like I said, coasting financial independence wasn’t the end goal they wanted to be fully Financial independent.
They keep working and investing for now. The next level is level 5 Financial Security which is achieved when their cash flow from your Investments is greater than your annual survival expenses. Remember that, that is $3,000 a month in John and James case. Since they are debt-free are making good money at their jobs and are being intentional with their finances. They achieve financial security in a little over four years. With over $367,000 in there for portfolio, it is been a mere 87 months or 7 years and 3 months since they began their financial Journey.
John and Jane are 30 years old and they’re able to get by on their Investments alone. In theory, they could retire right now, it wouldn’t be the most glamorous or retirement by any stretch of the imagination. It wasn’t their goal but it is an option they do technically have. They don’t have to worry about losing their jobs anymore because even if both of them lost their jobs immediately, they would be able to make it long enough to either find a new job or some other source of income like a side hustle. This is really the first level like I said where you get that piece of mind at least in my opinion.
Their next goal is to achieve financial flexibility which like I mentioned earlier has a few different definitions. The one all use in this article is roughly half of full financial independence. which were John and Jane will be roughly $600,000 or about $855,000 before accounting for inflation. This means that they would only take a couple more years to reach financial flexibility. Nine years and eight months into their journey not accounting for inflation and 11 years and 9 months if we do account for inflation. I’ll explain why I’m breaking those two up here in a bit.
John and Jane continue investing through all the highs and lows of the market until they reach full financial independence. Exactly fourteen years into their financial Journey assuming we don’t account for inflation or 18 years and 3 months assuming we do. You might be wondering why do I split up the accounting for inflation timeframes and the not accounting for inflation time frames. Shouldn’t we always be accounting for inflation? Well technically yes, but the reason that I split them up in this article is that in my experience taking this journey myself. Also, having seen some other people take it.
This journey changes how you view a lot of things especially money. More often than not, from what I’ve seen and what I heard, these changes tend to lead to your value in things such as freedom of Mobility location and time more than Valley Wings material things. Often times that leads to you actually spending less than you did when you started the journey. That’s not to say that everybody becomes minimalist going through this journey. I’m not saying that at all.
What I have noticed in myself and from what I’ve seen from others is that a lot of people who have gone through this journey become closer to minimalist than they were when they started. They find out more things that they used to buy just don’t provide enough value, happiness or excitement for them to be worth the money that they’re spending. Then they find better uses for their money and for their time. This means that even though inflation is technically increasing all of our expenses by making every dollar less and less valuable over time. If you’re also decreasing your expenses because what you value is changing. it may even out. In many cases from what I’ve seen and in my own personal experience you actually see your regular expenses going down year-over-year.. as you continue through this journey. That’s why I split them up.
Before I go I do want to mention that based on what I’ve seen on various articles and forums some people really like to have even more goals to chase as they go through this journey than what I’ve laid today If that’s something that you would think would help you feel free to break down these levels even further than I have today. This is obviously the list I personally used and what works for me. You could take it even further just off the top of my head the debt Freedom could be broken down into three separate stages.
One where you’re free from all high-interest debt. A second where you’re free from all debts except for the house if you have one, and a third where you’re totally debt-free. You could tackle the coasting financial independence level in a similar way breaking it down into two stages. One was you have invested enough to survive and retirement and a second where you have invested enough in order to maintain your current lifestyle adjusting for inflation in retirement. The financial independence level could also be broken down into three stages. Stage one would be where you’re at a survivable level of financial Independence. Stage 2 would be where you’ve achieved lean-fire status. Stage 3 would be where you’ve achieved full financial independence on your current lifestyle, assuming of course lifestyle is above the lean fire level. Otherwise, you can switch around.
What do you think of this 10 level system of tracking our progress to financial Independence? do any of you use a similar system to track your own progress? If so what is it and what level, step or stage are you currently on? Let me know in the comments section below.