Imagine knowing that the next 500 Mondays are going to be just as dreadworthy as the one coming up next week. It makes you want to quit your job almost immediately. Unfortunately you have a mortgage, bills to pay, food to put on the table and a car on finance. Thus you are resigned to the feeling that you are trapped in your job and the concept of financial independence or early retirement is nothing but a pipe dream.
Luckily, there are different stages of financial independence that can give you the power to take back your freedom bit by bit, so that you can slowly but surely break free from the trap. By identifying your true financial wants and needs you can calculate if you have reached stability, can take a lower stress job with less salary, or are able to quit the rat race altogether. The way I see it there are 7 stages and each have specific criteria before you can join the club.
Stage 1: Financially Dependent
Everybody starts at this stage.
It's when you must have a job in order to earn money so that you can pay for your expenses in life. That, or there is another person in your life bringing in the money and graciously supporting your cost of living also, i.e. your parents.
Without your job or financier your income will basically drop to zero and you're going to be faced with the challenge of how to pay your bills, your debts or put food on the table. You know... the basics and necessities of life.
Maybe you can last a short while, like a couple of weeks, before you need to start making difficult decisions - but that dreaded day is coming if you have no income.
Needless to say, this is pretty much the worst stage of financial independence because you basically have zero independence. Losing your job would be near catastrophic, and if you wanted to leave a job you didn't like you'd need to think twice to make sure you have somewhere safe to land.
The sad thing is that too many people in the world are in this stage. If you're among them then your only priority should be to start gaining some more financial independence by focusing on three key things:
Setting up your budget
Paying down your debt
Putting some money aside
Stage 2: Financially Stable
At this stage you're still quite dependent on a job but you're in a much better position to handle a situation where you might stop earning for a short period of time.
By this point you would have a sensible budget that works for you and it focuses the majority of your income into the important things such as debt payments, basic living expenses, and your savings.
Ideally you want to have no debts besides your mortgage, and perhaps a student loan depending on the interest rate. Everything else such as credit card bills, car finance, other loans with exceptionally high interest rates must already be eliminated.
You'll have an emergency fund that covers your cost of living for at least 3 months, ideally 6, and possibly more depending on your specific situation. This will give you a little bit of breathing room if your income suddenly stops coming in.
Finally you'll also have some savings for your future years, ideally in tax-sheltered or efficient accounts such as your pension or an ISA (Roth IRA if you're from the US).
Being financially stable may afford you a pretty decent life - one that's certainly better than someone else's who has to keep worrying what will happen if they lose their job next week. But it's very difficult to break free from the rat race if you stay at this stage.
Developing your financial independence further is going to require you to find ways to grow your wealth outside of your normal day job. Among these would be:
Earnings from investment growth and dividends
Income from side-hustles
Passive income or royalties from your products
Stage 3: Financially Growing
When you have money that is earning even more money, or are earning money from something you already did in the past, you'll become a member of this stage. Your job may still be your main source of income but it isn't the source of all your income.
Author's note: This is assuming you meet the conditions for Stage 2. If you have investment income but you're in a lot of credit card debt then you're not financially growing... at least not to your maximum potential.
One of the easiest ways to get your money earning more money is by investing it into a low-cost index fund that tracks a globally diversified benchmark and grows around 7% each year on average.
Don't underestimate this "low" rate of return because it's money you didn't need to work in order to earn and with the power of compounding it means your money will grow exponentially over time.
Besides investing you might have some skills that you're able to monetise and earn a little bit of extra money on the side. This will mostly require you to actively work - which has a limit due to time available - but if you're savvy you might be able to direct those extra earnings into building more passive income streams.
With a bit of focus and discipline most people can quite quickly get to this stage, but be prepared to spend a large amount of your time here. At the start it's going to be slow but as you build the momentum you'll eventually reach escape velocity that will allow you to leave the rat race.
The true indicator is that as each month passes you will be becoming more and more financially independent, meaning you are less and less shackled to your job.
The mission is to keep this going until you've finally transferred all of your dependence away from your job, and can live off your existing wealth and other income sources to the end of your life.
But, there's more!
Stage 4: Coasting to Retirement
As you continue transitioning your dependence away from your job you will reach a stage where you have enough of a nest egg that effectively means you never need to save again.
There's just one caveat - the money is only enough to last your traditional retirement and still needs to grow between the time from now until you reach the age of 67 (or whatever the retirement age for you will be).
Let's say for example you're 45 years old and your retirement age is 67, and you've calculated that you need £20,000 each year to live while in retirement. Your savings will have 22 years to continue growing where it will hopefully reach an amount that can support your retirement lifestyle.
At a 4% safe withdrawal rate that would mean you'd need to have £500,000 on your 67th birthday in order to have money that would, theoretically, last you for the remainder of your life.
Assuming your savings are invested into a low-cost index fund that returns 7% each year on average you would need to have roughly £113,000 saved up at the age of 45 to achieve this. Here's the math:
Savings invested into a low-cost index fund at age 45: £113,000
Years to grow: 22 years
Average annual return: 7%
Savings after 22 years of growth: £500,635
£113,000 x (1.07^22)
What this means is that once you've hit that £113,000 milestone for your savings you can effectively stop, and spend every penny you earn from that moment on without too much concern about your future - since you've already set something up for yourself.
Thanks to this you're going to get your first taste of real financial independence because you can choose to keep working your job as usual - basically keep going - or you could take a lower paid but lower stress job to keep you going until you reach retirement.
The choice would entirely be yours!
In my opinion this is also the stage where you can have the first taste of "F**k you money". While you're still going to need to work in order to support your "present day" living costs - you're not fully financially independent just yet - you don't need to be too concerned about your financial future.
A top tip is to build up your emergency fund to an amount that could give you a considerable amount of time to live without earning any more money.
Imagine knowing that your retirement years were secure and having the money in an emergency fund that could support your current living costs for the next 12 months. The moment you get sick of your job you could simply say "F**k it" and move on.
Stage 5: Financial Independence
At this stage you can finally make the decision to stop working and live off your current wealth and investments for the rest of your life, regardless of your age, albeit that lifestyle might be quite basic.
To get here you would have needed to continue to "Financially Grow" beyond the "Coasting to Retirement" stage. The more of your monthly income you're able to save and invest, the sooner you'll get here (obviously).
Let's say you spend on average £1,500 a month on general living costs covering housing, bills, groceries, new clothing (infrequently), and other basic activities. At a 3.5% safe withdrawal rate that would mean you'd need to have roughly £515,000 in your current investments in order to support that cost of living. Here's the math:
Annual cost of living: £18,000
(£1,500 x 12 months)
Investments balance: £515,000
Withdraw 3.5%: £18,025
(£515,000 ÷ 100) x 0.35
New Investments balance: £496,975
Grows by 7% on average each year: £531,763.25
£496,975 x 1.07
You might have noticed that in this example I am using a 3.5% SWR instead of 4% like in the earlier example. This is because my assumption is that you need your money to last longer, potentially a lot longer.
While the safe withdrawal theory says your money will keep lasting you your lifetime or even increase over time (as seen in the above example), you never know what will happen in the future when it comes to returns on investment. Therefore the lower rate simply accounts for this and you can always increase it in future if things are playing out quite well.
Author's note: An assumption I've made is that all of your money is coming from investments that you're drawing down from. However, other passive sources of income such as rental income, or income from royalties would also count and could lower the amount you need to have invested.
Now you really have "F**k you money" because you no longer need to work if you don't want to.
Bored of your job or what you're doing - just quit!
Don't like your colleagues, your boss, or your customers? - stick it to them!
Got fired - who cares?
You're truly financially independent by this point and any further income you earn on top of what you already have or would've been earning - for example continued growth in your investments - would be "excess" and not "required", although it would improve your quantity of life.
This is an important difference between this stage and the next - at this stage you're fully independent but your income is only able to support the basics of life.
You can enjoy simple hobbies like road trips, hikes, outdoor activities, family days, homecooked foods and the occasional activity. But you'd need to think twice or plan a little in order to be able to partake in some things that could be slightly more costly.
If that's what you're looking for then you'll want to keep going until at least the next stage.
Stage 6: Financial Freedom
This is the stage that most people are probably wishing to get to whenever they're thinking or talking about financial independence. It's where you're able to afford the relatively average lifestyle you want plus include some luxuries that you personally feel are worth paying for.
Examples of things you would be able to easily spend money on at this stage are: Regular holidays abroad, a decent car, weekly meals out in nicer restaurants, new clothes more regularly (but not the designer stuff), paid clubs and hobbies for your children.
While the actual amount of money spent each year is going to vary from person to person - or family to family - a benchmark number for this stage of financial independence seems to be $40,000; probably based on a 4% safe withdrawal rate on a million.
But let's just say £40,000 since this is a UK based blog.
At £40,000 income you would have £3,333.33 to spend each month which is more than sufficient to support a family of 4 people in most areas of the UK, especially if you're mortgage free.
As long as you're living a normal life you'll be comfortable. Meaning you mostly cook meals at home, you have a gym membership, you go on family holidays once a year, and you buy new clothes every couple of months. You know, the same things that you would've done when you weren't financially independent
The only real difference is that you're not trapped in a day job and you can do whatever you want with those hours you have back in your life.
Like I said before, when most people think about financial independence they're talking about this stage. But for those who want to life of more luxury there is one more stage.
Stage 7: Financial Abundance
This stage is where you have much more money than you need and are able to live a life of luxury. In other blogs, forums, or financial independence communities you might hear this being referred to as "Fat FIRE".
Holidays abroad happen multiple times a year, you have a nice car (better than a decent one), you mostly eat out at restaurants, you have a pretty big house, you can buy designer clothes and accessories, and you can send your children to private school.
How luxurious a life you lead will of course depend on your level of income but the benchmark appears to be at least £100,000 a year in spending money. At a 4% withdrawal rate that would mean you need an invested net worth of £2.5 million.
Getting to this would require quite some level of effort and possibly not worth it for people with a focus on early retirement.
Let's say you have achieved stage 6, Financial Freedom, and have a net worth of £1 million. If you were to keep saving and investing £1,000 each month from that point it would take you another 13 years to surpass £2.5 million assuming a 7% average annual return.
If you were to save and invest £3,000 a month it would take 11 years.
At £5,000 a month it takes 9 years.
Don't forget you're starting from £1 million and not £0.
A little bit of luxury in life isn't a bad thing but if you need to keep working another decade before you can "afford it" then you might want to think about the true value of those things - don't lose sight of your original goal!
Personally when I first started on my own journey towards financial independence I found it really daunting due to the massive number I would need to reach.
Even by investing my savings I was looking at quite a number of years before retirement was a real prospect for me. Even though I would be retiring early, in my mind it wasn't early enough and I found it highly demotivating.
But, by breaking the goal of financial independence into stages, and realising that I actually wanted the last but one stage of "financial freedom", the mission started to become a lot more digestible.
Whenever I start to feel hopeless about the whole mission I remind myself of these stages, and when I see where I've managed to get myself to since starting in 2015 I remember that everything is, in fact, going very well.
Once I remember that small fact I become a lot more focused, motivated, and more importantly patient.
Hopefully it can do the same for you too - keep going!
Hey - just one final word before wrapping up - Throughout this article I mentioned a couple of practices and habits to help you make progress and reach the various stages of financial independence. After reaching out to some other writers there are a few interesting articles you might want to read to help you with some of those:
Become Debt Free: 5 Things You Can Do - Bee Money Savvy
How To Manage Your Debt - Broke Girl In The City
Side Hustle Income Reports - Side Hustle Directory
How I Made Over £1,000 This Month - Millennial Saves