Long-term financial goals can sometimes seem so big that they feel almost unattainable
especially when we’re just getting started on our road to financial independence.
I and many others like me in the financially independent, retired early community have
found it helpful to break down the goal of becoming financially independent into smaller
and more manageable levels of financial independence.
Not only because it makes it easier for us to track our progress, which in turns helps
us to stay motivated throughout the process, but also because it helps us get over that
initial hurdle of starting to chip away at this mountain of a task.
In today’s video, I’m going to take you through what I consider to be the 10 levels
of financial independence as well as give an example on how to go from the first level
to the top level in your lifetime.
Hey everyone Daniel here and welcome to Next Level Life a channel where you can learn about
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Now obviously these ideas of the levels of financial independence are not solely my own
nor are they very new as there are many articles and blog posts that have covered this topic
already and have done so for many years.
So consider this more of a summary of many of the ideas expressed in those articles and
if you want to learn more about the topic feel free to check out some of the articles
for yourself.
I’ve left some links in the description.
With that out of the way, let’s get started.
Okay so real quick the 10 levels of financial Independence are Level 0 Financial dependence,
level 1 Financial solvency, level 2 Financial stability, level 3 debt Freedom, level four
coasting Financial Independence (also sometimes known as freedom from employer), level 5 Financial
Security, level six Financial flexibility, level 7 Financial independence, level eight
Financial Freedom, and finally level 9 Financial abundance.
The levels are usually defined as something like the following:
Level 0 - Financial dependency is when your debt payments and other living expenses are
greater than your own income.
This means that you are in one way or another dependent on someone or something else to
help you pay for your bills or if you happen to be a kid and don't actually have any bills
you need someone else, usually your parents, to pay to put food on the table and keep the
lights on and have a roof over your head.
This is the level that all of us start out on and it is referred to as level 0 because
as a financial dependent you obviously have no Financial Independence.
Level 1 - Financial solvency is when you are current on all your debt payments and you
can meet your financial commitments and your other living expenses without any outside
help.
Level 2 - Financial stability is usually defined as when you have built some sort of emergency
fund in addition to being financially solvent.
Level 3 - Is again debt freedom and it's defined differently depending on who you ask.
For some, it is being completely debt-free, mortgage and everything.
For others, it's being just free of the high-interest debts like credit cards but you still might
have a mortgage or other debts like student loans.
And for some others, it is paying off all of your debts except for the mortgage but
your credit cards and student loans or car loans all that stuff is all paid off.
Level 4 - Coasting Financial Independence also sometimes known as freedom from the employer,
Barista Financial Independence, or Agency in blogs and other mediums.
I personally like the idea of it being coasting Financial Independence so that's what I'm
going to be using in this video but know that some people refer to it by one of those other
titles but the idea is the same.
You have reached the level of coasting Financial Independence when you could, if you wanted
to, step down from a job that may be higher-paying but may also be either less satisfying or
more stressful or both into a new job that is lower paying but more enjoyable or less
stressful or both.
This is because in the early years of your career or just thought most recent years you
have managed to save a very decent sum of money that would be able to provide for the
later years of your retirement after it has grown even if you don't put much more in.
Therefore all you need to do is make enough money to get you to age 60 or 65 or 70 or
whatever your numbers work out to be when that amount of money you've already invested
will be able to fund your lifestyle because it's been given enough time to grow.
So in a sense, you've worked really really hard and been very frugal in the first few
years so that you can coast into your retirement.
I have gone into more detail on the various types of financial Independence in a previous
video which I'll leave Linked In the description if you're interested in learning more.
Level 5 - Financial Security is effectively when your cash flow from wealth such as you
are investments has grown to large enough that it can provide for your annual basic
survival expenses.
Now 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.
This does not include things like Netflix subscriptions or cable bills or things like
that it is purely survival expenses.
So this may not be exactly the ideal spot to retire and I certainly wouldn't want to
retire at this point but it is an important level to keep in mind because it does give
you...
well security.
If you were to get fired today and you were on level 5 you would be okay you could survive
until you found another job.
This is essentially the first level that really gives you I guess that piece of mind even
if the lifestyle should you have chosen to live it may not be the most lavish.
Level 6 - Financial flexibility is similar to Financial Security just one step up.
It is when you have the ability to live off of your current cash flow from your wealth
assuming that you have a flexible spending plan that adjusts for up and downs in the
market.
So if the markets up 20% one year you're able to spend a little bit more but if the market
is down 20% the next year then you don't spend quite as much.
I’ve seen it defined many different ways so it could vary depending on who you ask,
but the one that I personally like the most is that it is roughly half of your full financial
independence goal, or roughly about 12.5x your current annual expenses if you follow
the 4% rule to get an idea of how much money you need to retire like I’ve explained in
previous videos.
So it isn't quite Financial Independence yet but it's close.
Level 7 - Is financial Independence and it's usually based on the 4% rule which I have
covered in a previous video.
You can follow the 4% rule when you have saved roughly 25x your annual expenses.
The vast majority of the time this will be enough money to allow you to maintain your
current lifestyle in retirement and as a result, you can be considered financially independent.
And some articles end it right there but I think there are a couple of levels that are
a bit higher than that that are worth considering even if some of us may decide to not ever
try to achieve them because being at level 7 allows them to do what they wanted all along.
So let's talk about those other levels.
Level 8 - Is Financial Freedom which I've often seen defined as the cash flow from your
Investments is greater than financial Independence and a few more life goals.
Life goals, of course, will differ for everybody but this is could be something like taking
a trip or two overseas or moving to a new place you've always wanted to live but haven't
had quite enough money to live there up till now or whatever the case may be for you like
I said it's different for everybody.
Level 9 - Is financial abundance and this is quite simply just that the cash flow from
your Investments is more than you will ever need.
You could spend it if you really wanted to but it would actually take some effort.
And the stuff from level 8 doesn't really cut into it much at all.
So you could up those goals even more and still have more cash flow left over at the
end of the year.
This also probably has a slightly different definition for each person depending on who
you ask, but I like to think of it as roughly 3x your financial freedom number because this
would allow you to experience a horrible bear market where your investments go down by 50%
and still has 1.5x the amount that you would need to maintain the lifestyle you lead when
you reach level 8.
To me, that means that it is likely more than you will ever need, but again that one is
strictly my own opinion on the matter.
So those are the 10 levels of financial Independence, now let's walk through a hypothetical example
of how someone could go from Level 0 to being financially independent in a single lifetime.
John and Jane are recently married couple each making $20 an hour at age 23 or $83,200
a year between them assuming no overtime.
They manage this because they are not only good hard-working people but got great grades
in school and we're selective about the job that they decided to pursue.
Obviously just like everyone else they would have started off as Financial dependents and
as they were going through college they would have been building up student loans that they
would not have had the money to pay off (assuming of course that they didn't earn enough money
while in school to keep up with the rising debt).
In all they have credit card debt, two car payments and the student loans which have
balances of $5,000, $35,000, and $60,000 respectively, but 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 the regular monthly debt payments, their annual expenses are $48,000 a year.
So they are currently in level one Financial solvency and trying to figure out a way to
move to level 2 Financial stability.
In order to do that they need to figure out a way to build up an emergency fund.
Now if they're following the 10 levels system to a T 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 say if you were to follow Dave Ramsey 7
baby steps you would start off with just a $1,000 starter emergency fund and then get
right onto attacking your debts.
And other Financial systems and plans may have you approached it an entirely different
way.
Either way is perfectly fine because the 10 levels system is not meant to be a financial
formula per say it's more there to give us some sort of guidepost so that we can better
track our progress towards achieving Financial Independence.
But for the purposes of this video, 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 how much of an emergency fund they will need we 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 which are basically your four walls of your
financial house or in other words food shelter including utilities Basic clothing and some
form of transportation as well as the insurances that are related to that assuming there are
any.
In this case, I'm going to assume that their survival expenses are right around $3,000
a month.
Which means that in order to get a 3-month emergency fund they would need $9,000 in order
to get a six-month emergency fund they would need to save $18,000.
Both John and Jane feel that their jobs are pretty darn secure and the market is doing
fairly well so it's not likely at least in the near-term that they would get laid off
because the company has to downsize so they decide together that they are comfortable
with having just a 3-month emergency fund of $9,000.
So with $83,200 a year in income, $48,000 a year and expenses, plus minimum monthly
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 $1,660.72 a month left
over to start building their emergency fund.
However, both John and Jane have been looking into their finances and researching a lot
lately and they become fired up at the possibility of becoming financially independent while
they're still young.
So they want to see if there's a way that they can speed this whole process up.
And as it turns out thankfully there are many.
After taking a look at the options they decide 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 manage to work
on average 5 hours per week of overtime which will increase their monthly income by about
$1,300 a month, meaning that instead of $1,660 a month they will have $2,960 a month left
over) and 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
that is willing to give them $15,000.
So they take that $30,000 and use $5,000 of it to pay off the credit card balance and
another $10,000 to buy a couple of used cars from someone that they know takes good care
of their Vehicles whether that be a family friend or just a 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 the hundred-dollar
minimum payment is no longer needed.
So John and Jane start throwing $3,060 per month into their emergency fund and get it
fully funded in 3 months with a little bit left over at the end of the third month to
throw out their car loan.
Over the course of those first three months, they managed to bring the car loans balances
down to $18,423 thanks in large part to the $15,000 that they threw at it in the first
month after selling the cars and also making the minimum payments in the first three months.
Now that their emergency fund is fully funded however they're able to throw that $3,060
a month in addition to the $550 a month minimum payment at the car loan and get it paid off
in 6 months flat.
So a mere nine months into their Journey John and Jane not only have a fully funded emergency
fund but they also have paid off both of their car loans.
Now there are just the student loans to tackle.
And thanks to the fact that they've been making minimum payments on them for 9 months and
the fact that they had a little over $3,000 at the end of the ninth month 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 did with the car loans throwing the $3,600+
which is what they now have left over at the end of every month because they no longer
had a $550 car payment to make and they managed to get their student loans paid off in full
in 13 months.
So John and Jane have managed to become debt free and have a fully funded emergency fund
in 22 months.
They have now reached level three and because of that they now have over $4,200 a month
left over to start investing.
This brings us to level four 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 a rate of return on an average in the market of about 10% before inflation
and an inflation rate of 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 case, since they're 24 about to be 25 they will have somewhere in the neighborhood
of 39 or 40 years to let the money grow before needing to take any of it out.
If their expenses were $48,000 a year at age 23 then 42 years later if we assume a 3% rate
of inflation they would need a tad bit over $166,000 each year to live on.
Again 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 have to have at least $4.15 million
invested in the market by the time they turn 65.
In their case, they would need about $110,000 saved up give or take in order to achieve
coasting Financial Independence and because they're 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.
Meaning that in theory, they would be able to step down from their jobs to a more rewarding
less stressful but probably lower-paying job just 3 years and 10 months into their financial
Journey.
That is incredible!
But like I said coasting Financial Independence wasn't their end goal.
They wanted to be fully Financial Independent so they keep working and investing for now.
The next level is level 5 Financial Security which is achieved when your cash flow from
your Investments is greater than your annual survival expenses which remember is $3,000
a month or $36,000 a year in John and James case.
Because they are debt-free, are making good money at their jobs, and being intentional
with their finances they Achieve Financial Security in a little over 4 years with over
$367,000 in their 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 are able to get by on their Investments alone.
In theory, they could retire now, it wouldn't be the most glamorous retirement and it wasn't
their goal but it is an option they have.
They don't have to worry about losing their jobs anymore because even if both of them
lost their jobs today they would be able to make it long enough to either find a new job
or some other source of income.
This is really the first level where you start to get that piece of mind when it comes to
money at least in my opinion.
Next is financial flexibility which as I mentioned earlier in the video has many definitions
depending on who you ask but for the purposes of this video, I'm assuming that it is roughly
12.5x your current annual expenses which for John and Jane would be roughly $600,000 or
about $855,000 if you account for inflation.
This means that they would Achieve Financial flexibility 9 years and 8 months into their
Journey not accounting for inflation or about 11 years and 9 months if we do account for
inflation.
John and Jane continue investing through all the highs and lows of the markets until they
reach Financial Independence exactly 14 years into their financial Journey assuming we don't
account for inflation or 18 years and 3 months if we do.
So you might be wondering why did I split up the accounting for inflation time frames
and the not accounting for inflation time frames should we always be accounting for
inflation?
Well technically yes but the reason I split them up is because in my experience taking
this journey myself as well as seeing others take it, this journey changes how you view
a lot of things and more often than not those changes lead to you valuing things such as
freedom of mobility and location and freedom of time to be able to spend with the people
you love more and valuing more material things that cost possibly a lot of money less and
less.
That's not to say that everybody becomes minimalist going through this journey, I'm not saying
that at all but I have seen a lot of people who have gone through this journey become
closer to minimalist than they were when they started the journey as they find out more
and more things that they used to buy just don’t provide enough value or happiness
for them to be worth the purchase.
They find better uses for their money and time and as a result, they generally tend
to spend less.
Which means that even though inflation is technically increasing your 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 or in some cases, you may even see your regular
expenses going down year-over-year as you continue through this journey.
So that's why I split them up.
And, 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 out today in this video so if that's something that
would help you feel free to break down these levels even further then I have today this
is obviously just the list that I used and what worked for me, but you could take it
even further.
For example, Debt Freedom could be broken down into three separate stages: One where
you are free from all high-interest debt, a second where you are free from all debts
except for the house (if you have one), and a third where you are totally debt-free.
You could tackle the coasting Financial Independence level in a similar way breaking it down into
two stages: One where are you have invested enough to survive in retirement and a second
where you have invested enough in order to maintain your current lifestyle, adjusting
for inflation of course, in retirement.
And the financial independence level could also be broken down into three stages: Stage
one would be where you are at a survivable level of financial Independence, stage 2 would
be where you have achieved leanfire status, and stage 3 would be where you have achieved
full Financial Independence on your current lifestyle assuming that it is above the leanfire
level.
So what do you guys think of this 10 levels system of tracking our progress to financial
Independence?
Do any of you use a similar system to track your progress?
If so, what is it and what level, step, or stage are you guys currently on?
Let me know in the comments section below.
But that'll do it for me today once again if you enjoyed this video be sure to subscribe
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