5 Stages of Financial Independence
Where are you on the journey to financial freedom?
Financial freedom is something many of us aspire to: the ability to never worry about money, have the option to quit your job without repercussions, or retire early and spend your time doing what you truly love instead of doing what pays the bills. But how far are you on the road to financial freedom? Knowing where you stand can help you figure out where to go and make your aspirations clearer.
Here are the different stages that we consider useful when we think about financial freedom.
Stage 1: full financial dependence. In this stage, you have zero income, but obviously still have basic needs: food, a roof over your head, clothing, education, healthcare. A testament to the circle of life, this is the stage we are born in and some of us also die in. Unless you are an orphan who had millionaire parents, you grow up being fully dependent on your parents (and the government) for all your needs.
If you don’t plan prudently for retirement – for example by withdrawing a portion of your EPF savings that should go to your retirement – or you experience a severe financial setback, you may also end up being fully financially dependent. However, this time you will likely not depend on your parents, but on your children. Once you start working, you will leave this stage. You want to escape this stage because you want freedom from your parents.
Stage 2: financial solvency. In this stage, you are earning an income which is sufficient to pay your monthly household expenditures as well as any payments for loans you may have. At the bare minimum, your savings are not shrinking, and perhaps you are able to add just a bit every month to your savings. Notice, that this doesn’t mean you don’t have any debt, but it means your income is enough to timely pay all your loans. In this stage, you could still live pay check to pay check. You want to escape this stage because you want freedom from the stress of making ends meet.
Stage 3: financial stability. In the previous stage, you are still financially vulnerable for any unforeseen event; a car that breaks down, unemployment or a serious illness. In order to be financially stable, you will need to have a financial buffer that can withstand these shocks without significant impact on your lifestyle, for example, savings that can cover 6 months of your monthly living expenses. You want to attain this stage because you want peace of mind.
Stage 4: ‘Screw you’ money. This phase typically requires you to have paid off all your debt, including your housing loan and student loans. Your savings are not just enough to bridge your spending for a few months, while you find a new job. Instead, it allows you to quit your job and stay unemployed for multiple years if that’s what you wanted. It allows you to say ‘screw you’ to your boss or whoever else because you are no longer financially dependent on anybody.
At least a portion of your income no longer comes from employment, but is income from the investment of your savings. You want to attain this stage because you want freedom from your bank and your boss.
Stage 5: financial freedom. In this stage, you not only have enough savings to last for a few years, but for the rest of your life! Obviously, its a big step to go from having savings for a rainy day, to living completely off of them! It means the income from your investments, funded by your savings will be more than enough to fund your lifestyle, including inflation. Sometimes this stage is broken down, depending on whether your savings can partly fund your lifestyle, fully fund your current lifestyle or allow you to live more abundantly than you currently do. You want to attain this stage because you want freedom from any employment.
It is definitely not easy to travel through all stages, especially with the rising cost of living in Malaysia. However, if you start early and keep your eyes on the destination, achieving stage 3 should be attainable for many Malaysians in their 30s and 40s and stage 4 for many in their 40s and 50s. Achieving financial freedom is a long-term goal that can start on any day, why not today?