Stage 0 – Dependence
In this stage, your lifestyle depends on others for financial support. We all start here. We’re born this way. How long it takes to break free varies from person to person. You’re in this stage if you rely on financial support from your parents. You’re in this stage if you spend more than you earn. You’re in this stage if your debt payments exceed your income.
After you begin to earn a profit, you begin to progress through the six stages of financial freedom. The first three are the “surviving” stages.
Stage 1 – Solvency
Solvency is the ability to meet your financial commitments. You reach this stage when you no longer rely on anyone else for financial support — when your income exceeds your expenses, when you are no longer accumulating debt. When you are earning a profit, you have achieved solvency. Some people reach this stage in their teens. Some never reach it. (I reached it at age 35 in October 2004, when I stopped debiting and began to repay what I owed.)
Stage 2 – Stability
You achieve stability once you’ve repaid your consumer debt, established some emergency savings, and continue to earn a personal profit. You may still possess some “good debt” — college loans, a mortgage — but you’ve eliminated other obligations and built a buffer of savings to protect you from unfortunate events. (I reached this stage at age 38 in December 2007, when I made my final debt payment.)
Stage 3 – Agency
The final “surviving” stage is free agency, the ability to work and live how and where you want. In this stage, you’ve eliminated all debt (including student loans and mortgage) and you have enough banked that you could quit your job at a moment’s notice without hesitation. This is commonly called “screw-you money”. (I achieved agency in March 2008.)
Note: I know first-hand there are times you might prefer to carry a mortgage even if you don’t have to. For the purposes of this stage, if you have enough saved and invested to pay off your mortgage, it’s the same thing as not having one.
In the final three stages, you move from surviving to thriving. Money is no longer a safety net, but a tool to help you build the life you envision for yourself and your family. Remember our discussion of the “crossover point” last week? That concept is key to defining where you are in these latter stages of financial freedom. (Each of these stages assumes no debt. Or, as explained in the note above, enough cash on hand to instantly repay your debt.)
Stage 4 – Security
You achieve financial security when your investment income can cover your basic needs. That is, based on how much you have saved and invested, you could live a meager existence for the rest of your life. Even if you never worked another day in your life, you have enough to afford simple housing, basic food, essential clothing, and insurance.
Stage 5 – Independence
Financial independence is the ultimate goal for most folks. At this stage, your investment income is sufficient to fund your current standard of living for the rest of your life. You can afford the basics, but you can afford some comforts too. You have enough. (I leaped from agency to independence in April 2009. This is the stage I’m in today.)
Stage 6 – Abundance
In the final stage of financial freedom, you have “enough — and then some”. Your passive income from all sources will not only fund your lifestyle indefinitely, but grant you the freedom to do whatever you want. You can share your wealth with others. You can indulge in luxury, explore the world. You can build a business empire.
The more money you save, the more freedom you have, and the greater risks you can take. As your financial independence increases, you chip away at the wall of worry. You’re able to make decisions based on happiness and not on dollars.
And here’s the thing: As you develop smart money habits and skills, these will not only help you obtain whatever immediate level of financial freedom you’re working toward, but also progress toward future levels of freedom.
If you’re working toward debt freedom, for instance, as you learn to spend less and earn more, this profitability will continue to help you once you’ve achieved solvency. You can apply the same ideas as you work to obtain stability, and then agency.