The stages of financial freedom: The road to financial independence

The stages of financial freedom: The road to financial independence

Today we're going to explore the six stages of financial freedom. First, though, I want to introduce you to my friends Mac and Pam.

Pam is a pathologist and an elite ultra-runner. Mac is a former high-school science teacher and current stay-at-home dad. Together, they form a formidable financial team.

They're also a couple of nerds. I mean, look at them!

[Pam and Mac]

Maybe because they're such nerds, Mac and Pam have always put an emphasis on saving. But they don't just pinch pennies. They've optimized their lives to boost their income and their happiness. They're well on their way to financial independence. In many ways, they epitomize the ideals espoused by my Money Boss philosophy.

The Money Boss Method in Real Life

When Pam was in her final year of med school, for instance, Mac worked as a research tech at a neuroscience lab. He brought home only $18,000 but they were careful to avoid living paycheck to paycheck.

“We would pay the rent,” Mac says, “we would put money into savings, and we'd still have money left over at the end of the month. We made choices not to buy the little things that could have killed our future.

After med school, Mac and Pam moved to Portland. While Pam did her pathology residency at Oregon Health & Science University, Mac taught high-school science. At that time, their salaries were similar.

When their first child was born in January 2005, Pam took maternity leave until Spring Break. From Spring Break until the end of the school year, Mac brought the baby with him to work and placed her in the student-run daycare.

“Counting the cost of daycare, my teacher's salary went down to minimum wage,” Mac says. At the end of the school year, he asked for a year off. That year turned into forever. “It came down to whether I wanted to raise other people's kids or whether I wanted to raise my own.”

The traditional choice is for the mother to stay home with the kids, but that seemed silly in their situation. With her residency completed, Pam could earn four or five times what Mac could make as a teacher. “It didn't make sense to throw away the money we spent on Pam's education to not reap the benefits of that education.”

For the past decade, Mac and Pam have worked in tandem toward family and financial goals. Pam makes the money. Mac takes care of two kids and day-to-day household operations while also managing their investments. They're both careful with spending.

“We spend a lot less than all of our friends who earn similar amounts,” Mac says. “Lots of our doctor friends have multiple houses. They own fancy cars. They spend lots of money and we don't. Neither of us wants a second home. I drive a 2007 minivan and Pam drives a 2004 Avalon. Our only debt is our house. We pay off our credit cards every month and we have no car payments.”

From the beginning, saving has been a priority for Mac and Pam. And as they earned more, they saved more. It's true their spending increased too, but at nowhere near the same rate. A higher income meant they could put more in the bank — not buy more stuff.

Because they've been so diligent for so long, Mac and Pam will be able to retire in their forties. They've made the choices and done the work necessary to achieve Financial Independence at a young age.

“We'd rather accumulate our wealth, to live how we want later in life than spend on things now,” Mac says. Yes, they could afford to buy things today, but doing so would require sacrificing more important opportunities tomorrow.

These two are money bosses! They've been climbing the ladder of financial freedom for a long time.

[The Smith Family]

The Six Stages of Financial Freedom

I used to believe that financial freedom meant just one thing: Having enough money that you never had to work again. Over the years, people like Mac and Pam have taught me that financial independence exists on a continuum. It's not “all or nothing”, but an ever-increasing range of options. It's a process.

Each stage of financial freedom allows you greater autonomy and self-expression, and these are qualities that lead to happiness.

Nearly a decade ago, I came up with what I called the three stages of personal finance. Later, I expanded this to four or five stages. Today, I recognize there are many degrees of financial independence.

For our purposes, we're going to keep things simple.

After blending my ideas with those of Joshua Sheats at Radical Personal Finance, I've come up with a model that tracks six stages from financial dependence to financial abundance.

But before you can begin progressing through the six stages of financial freedom, there's a preliminary hurdle you have to clear. You're in this “zeroeth stage” if your expenses exceed your income.

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 debting 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” earlier this 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.

Note: Where am I on this scale? I've definitely achieved Financial Security. If you'd have asked me a year ago, I would have told you that I was solidly in stage five, Financial Independence. Honestly, that's probably still accurate — but a lot about my financial situation seems less certain than it did a few months ago. That's a topic for another conversation…

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.

I spent far too long this morning playing in Photoshop to create the summary below. I am not a graphic artist…but I try.

[The Stages of Financial Freedom]

Summing Up

That's it for migrating the Money Boss crash course to Get Rich Slowly!

Over the past few weeks, I've shared the nuts and bolts of my financial methodology. To summarize:

  • You are the boss of you. Nobody cares more about your money than you do, so assume responsibility for your financial future. Run your life like a business.
  • The best way to get what you really want is to become clear on your goals and values. That's why everyone should craft a personal mission statement.
  • Your saving rate is the most important number in personal finance. Savings — which I like to think of as “profit” — gives you the power to do what you want in life.
  • Frugality is the cornerstone of wealth-building, but the best way to spend less is to cut back on the big stuff.
  • You are 100% responsible for your income. To earn more, learn more. Work more and work better. Sell yourself. If you take the time to supercharge your income, your profits will soar.
  • Think like a billionaire by carefully guarding each dollar you earn. Recognize that every time you spend today, you're sacrificing a piece of tomorrow. Be wary of opportunity costs. Practice mindful spending.
  • Invest wisely. Don't try to get rich quick. Develop an investment philosophy and develop an investment strategy that supports this philosophy.
  • Use barriers and pre-commitment to automatically do the right thing — every time.
  • As you adopt this philosophy, your wealth snowball will begin to grow. The more you work at it, the bigger it'll get. Protect it. Your wealth snowball is the key to your financial future. Eventually, you'll reach the crossover point, that place where your investment income exceeds your day-to-day spending. You'll have achieved Financial Independence.

It was a lot of work to put this together, but it was also a lot of fun. I'd love feedback if you have it. I want this info to be as useful as possible to future readers, so drop me a line to let me know what you liked — and what you didn't. Constructive criticism will not offend me.

I've collated this series of articles into a free ebook called A Brief Guide to Financial Freedom. Like much of this material, it's still branded for Money Boss, but soon I'll revise everything to be GRS-specific.

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Jon Sharpe
Jon Sharpe
2 years ago

Hey JD I am definitely aligned to your approach and really like the stages that you’ve laid out above. For me, I would say that I’m solidly in Stage 4 with an aspiration to reach Stage 5 in seven years. At that point I’ll be 55, both kids will be done with undergrad, my employer will provide lifetime retiree medical benefits, and the ol’ 401k will be in the multiple seven figure range. This is all predicated on reasonable stock market returns between now and then of course…

Jason@WinningPersonalFinance
2 years ago

I’m so glad you republished this JD. I just drafted a post linking to the Money Boss version and will switch the link over now to this one before I publish in a few weeks. I think I’d be in the “security” phase but I’m not positive. If I pick up and move to a much less expensive area and cut the lifestyle down to the basics, I should be able to get by forever based on the 4% rule. On the other hand, I have a mortgage and don’t quite have enough liquid (non-retirement) assets to pay it off… Read more »

Gina
Gina
2 years ago

It is great to hear an update in a little bit about the financials of Pam and Mac. I used to follow along with Max adventures as you two were writing getfitslowly. I am glad their family continues to do well.

Pam
Pam
2 years ago
Reply to  Gina

Gina- I am happy to report that we paid off our mortgage two years ago and ten months ago (age 42) I quit my full time job (with weekend call) and now work per diem 2-3 days per week with NO CALL. I still enjoy my job and I am glad to be working some, but I am very happy with the reduced hours and obligations. Keeping some income allows us to cover our medical insurance (the downside of part time!), afford a few nice trips a year and otherwise minimize dependence on savings. Mac stays very involved with the… Read more »

Petra
Petra
2 years ago
Reply to  Pam

Good to read this! I was wondering how things were doing, reading this story from I guess a few years ago. Glad to read that you’re enjoying your life.

Bambam
Bambam
2 years ago

Another great post, thank you. One suggestion I have is to add a few links within each stage for moving past it or further elaborate on it. Like maybe the money blueprint link would help people understand why they are in stage 0 or spinnng their wheels in stage 1. And then for stage 1-2, a link to the debt snowball or the wealth snowball, along with links to some inspirational or motivational stories of those who did it. And so on through the other stages. This would add to the length but might provide clarification for those who haven’t… Read more »

The FIRE Engine
The FIRE Engine
2 years ago

Great post JD!

I’m currently in the Stability stage almost by default, having never had consumer debt and always kept my income above my expenses. Two years out of a five year university degree, I still have student loan debt (at a low interest rate) and a mortgage, and I’m expecting that when I do move on from Stage 2, there’s a good chance I’ll skip straight ahead to Stage 4!

Keep up the good work,

TFE

Catherine
Catherine
2 years ago

Hi JD, a fairly recent visitor from Ireland, but now a huge fan :-). This is a fantastic piece…well worth the time you spent putting it together (and as a fellow non-graphic artist, I think the Photoshop summary is great!). I agree with Bambam that you should add links to your other relevant content if people want to learn more detail. Personally I love (seemingly simple) summaries, but I also love being able to click on links for further info, before returning back to the main article. There are many wonderful PF authors, but you’re now up there as my… Read more »

Accidental FIRE
Accidental FIRE
2 years ago

I’m solidly in Stage 5, but I choose to remain part-time at my job to maintain my health plan. I can surely afford to go on the ACA, but if they dissolve it then, well, there’s that problem. My risk tolerance for our woeful healthcare situation is low. I’m content staying part time for now.

Joe
Joe
2 years ago

Nice story. I didn’t like other people raising our son either. He was in daycare for 18 months and we barely spent anytime together on the weekdays. Good move.
We’re in stage 5 and hope to get to stage 6 someday. I’d love to hear more about your uncertainties. What happened and how could you have prevented it?

Dicey
Dicey
2 years ago

Stage Sixer here. It is so much fun having both the time and the money to help the causes I care about. It was worth every bit of the effort to get there. JD, this site was one of a select few that inspired me along the way. I thank you for all the life energy you put into making GRS go. You helped me be able to help others. Powerful mojo indeed.

WantNotToWantNot
WantNotToWantNot
2 years ago

Another Stage Sixer here who reads this blog because J.D. writes well, gives excellent advice, and because I well remember my struggles up this financial ladder in my 20s and 30s. I made every mistake in the book and had to basically start over in my 40s. It was daunting and scary, but exhilarating too. I’m still working (because I enjoy my job) but planning to “retire” (however you want to define that) in another 18 months. It’s very gratifying to have the extra to give back now and we have set up a Charitable Fund to do that. I… Read more »

sarah@themoneydiary.co.uk
2 years ago

How did you move from stage 2 to 3 – paying off consumer debt to paying off mortgage – in 3 months, then from stage 3 to 5 – investment income sufficient to live on – in a year? Especially the leap to stages 4 and 5, it would imply we’d need to have built up significant investments during the earlier stages, which doesn’t seem possible in such a short period of time?

Amy
Amy
2 years ago

That would probably have been when he sold GRS–huge jump in net worth…?

Sarah@themoneydiary.co.uk
2 years ago
Reply to  J.D. Roth

Thanks for clarifying, makes sense.

The Surprise Millionaire
The Surprise Millionaire
2 years ago

So happy to rediscover GRS! It was your post on your former neighbor “John” back in 2008 that inspired me to profile the Surprise Millionaires on my own blog. John was a great example of how living below your means along with consistent long-term investing can really pay off over time. Thanks for introducing me to “John” and his amazing life!

S.G.
S.G.
2 years ago

Just a small comment from a veteran of the mommy wars: the term “other people raising my kids” is a little loaded. I know it was a quote. But it’s one of those phrases that hit me a long time ago when I was wrestling with daycare decisions myself.

Bambam
Bambam
2 years ago
Reply to  S.G.

Agree. The kids turned out ok despite the care from non-family.

Kate
Kate
2 years ago
Reply to  S.G.

There are so many ways people raise other people’s kids outside of daycare settings. I’m with you, it’s sometimes hard not to take parenting choices or commentary judgments personal.

In the end, all of us (and our children) are really raised by a community of supporters. The more I consider how many wonderful people are in my children’s lives over the years (and in my own), the more the sting of those types of comment hurts less.

Karen
Karen
2 years ago

I had printed off these stages from your money boss days when we were at stage 3. Now I’m happy to say we’ve moved onto security stage while we ensure our kid reaches independence (finishing her undergrad which we are paying for). Thanks for the revisit to a great post.

Mary
Mary
2 years ago

Hello, J.D.
I’m a solid 4-stager and in a bit of a pause. Like when you’re not sure how to make the next move wisely. Your guide is a gem, I’m glad I found it! If you ever choose to write about your story in more details, I’ll be looking forward to it.

Vic
Vic
2 years ago

First off, so glad you’re back. Second, sad to say I’m only at stage 2, steadily working to progress. Said to say in the area I’m from not many are looking ahead most are trying to above water. When you know better you do better. Very glad to say I’m learning more each day

Bob at The Frugal Fellow
Bob at The Frugal Fellow
2 years ago

It looks like I’m currently between stages two and three – but, I got a late start due to a mountain of student loan debt (which is now paid off). So I am certainly moving in the right direction. Now on to stage three!

Chris @ Mindful Explorer
Chris @ Mindful Explorer
2 years ago

Such a great blog post JD and I really enjoy going through lists like this to review where I am at as well as reaffirm to sticking to the list. Right now I am firmly on the Security stage as I want to see my investments continue to grow a bit more. I then plan to jump up to Independence once the numbers are a bit stronger. When the kids are completely on their own we will sell the house which will then jump us to abundance. Your posts will be helping us navigate the final 2 stages. Cheers

freebird
freebird
2 years ago

How about describing these stages in terms of what you can buy at each stage? #1 paycheck to paycheck: basic food/shelter/transportation #2 firm footing: an emergency that costs a months pay and retirement contributions with every paycheck #3 breathing room: 1-2 year sabbatical #4 leanFIRE/baristaFI: minimalist retirement, or cutting back to part-time indefinitely #5 FIRE: retirement at current standard of living #6 fatFIRE: plush retirement and trust funds for your kids The basic idea is you’re not measuring your progress in dollars but in units of time. Each stage you wrest control over progressively longer stretches of your waking hours… Read more »

Kate
Kate
2 years ago
Reply to  freebird

I really like this method you shared. Based on your comment, I would be in stage 3 on my way to stage 4 instead of stuck at stage 2 for a decade or more. Interesting take on how to look at the stages and steps up in each area.

Kate
Kate
2 years ago

I feel as though going from Stage 2 to Stage 3 is a HUGE jump. I’ve been stuck at stage 2 and will be for another decade or so. Being completely debt free without a mortgage and the ability to walk away from work is a massive leap from being out of consumer debt. I could be wrong, but it seems as though the first steps 0-2 one can move relatively quickly through when you get going (job, pay off debts, etc), but I can say from experience getting to step 3 will take probably double the amount of time… Read more »

Bob at The Frugal Fellow
Bob at The Frugal Fellow
2 years ago
Reply to  Kate

Totally agree there, as I am between 2 and 3 myself. The first 2 parts of stage 3 are non-issues for me (though I rent, so don’t have a mortgage). But quitting my job? Definitely not doable for me right now. Just that part alone is really tough.

In theory, I would think that stages after 3 could move faster due to compounding interest on your investments. But that could be a massive over-simplification.

Jen G
Jen G
2 years ago

I *think* I’m in Stage 4? The question mark is for health care. I’m 40 and all of our other expenses I can fairly accurately predict into the future. With a special needs son, we won’t be quitting our jobs until US health insurance uncertainty becomes more certain, so I predict we will be working for quite a while longer. It sounds like we may not be alone here. But having financial security, even if retirement isn’t forthcoming, is a really good feeling and worth every sacrifice.

Mark Edwards
Mark Edwards
2 years ago

I guess I’m at stage 5, but the jump from the second and third stages was super hard, I’d add some transitional stage there. Many of my readers wouldn’t be able to place them anywhere but between those two.

Thanks for such a massive explanation, though! I bet it’s hugely helpful to many people who still have a long way ahead.

Rebecca @ BackroadsMotorsports
Rebecca @ BackroadsMotorsports
2 years ago

Stage 2 and working diligently to increase our savings rate. Due to the economy and our ages, we will not hit stage 3 until we sell our home in 8 years. And then we will be close to a planned and budgeted semi-retirement of work camping and part time employment. We are continuing to look for ways to increase our income and save more which is more of a priority right now than paying off the mortgage.

Sara-Jayne
Sara-Jayne
2 years ago

I’m flittering between Stages 2 & 3 currently – not helped by the fact that I was laid off last month…right when I was doing so darn well with paying off student loan debt! But the silver lining was that I have enough socked away to not worry about grabbing the first thing that comes at me. I think that when you’re straddling two of these bases (for want of better terms!) is when it’s most difficult to be patient and know when to make that leap so you’re fully on one and not the other – anyone else have… Read more »

Victor
Victor
6 months ago

Thanks JD for the post. I am 42 and my wife is 38, we have two kids (8 and 5). I am going thru mid life crisis and the idea of early retirement has been hitting me for the entire year.

Not until I saw the post that I realized my family is probably at stage 5. I feel a bit better now 🙂

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