Financial Independence

The 7 Stages of Financial Independence

We talked about it in the past; we want to reach financial independence in less than a decade. There is no secret to reaching financial freedom; work hard, spend less than you earn, and save a large portion of your income.

For every dollar you save, you are slowly buying yourself time. If you are saving 75% of your income, you are buying yourself three years of retirement for each year you work.

Now, if you are investing in the markets and putting your dollars to work, the actual time you will need before reaching financial freedom will be minimal.

Once you have a considerable portfolio, you can start withdrawing 4% of your portfolio, valued at the first year of withdrawals, and then adjust for inflation (see Trinity Study). This four percent rule (or 3%, or whichever safe withdrawal rate you are comfortable with) can be adapted to your risk tolerance and appetite but four percent has generally sustained early retirees and has been well back-tested throughout the recorded history of our stock market (100 years or so). Once your safe withdrawal rate can completely cover your expenses and beyond, you have reached financial freedom!

We briefly talked about the stages of financial independence in the past but Joshua Sheats did a podcast about the 7 different stages of FI where he goes even deeper into the subject. We will go through his stages and expand on a few points we took to heart.


Stage 0: Financial Dependence

He starts by explaining how we all start as a dependent of our parents. They pay for all our expenses at first, and slowly, we start flying by our own wings.

If you are an adult and financially dependent, it is O.K. there is plenty of ways to get yourself out of it. Maybe you spend more than you earn or are struggling with student loan debt but whatever the reason, you have to pay off that debt as quickly as possible.

If your student loan interest rates are too high, consider refinancing to a lower rate through companies like SoFi. If you accumulated credit card debt, SoFi can also help you consolidate at a much lower rate with a personal loan.

Cut your expenses and start living within your means. There is no reason to keep up with the Jones. The Jones don’t even care about you or your finances. This will greatly accelerate your debt repayment timeframe and get you to stage 1  faster.


Grow your personal wealth towards financial freedom


Stage 1: Financial Solvency

Once you are able to support yourself on your own income without the aid of others and all of your bills are paid on time, you are financially solvent. This is where your own path to financial independence really begins.

To make you do not fall back to stage 0, make sure you track your spending, keep your main expenses in line, and keep a healthy emergency fund.

We use apps like Mint or Personal Capital to track all our spending and try to keep our Big 3 in line; Housing, Transport, and Food expenses.

Try to keep your total housing cost under 30% of your total income. This means someone making $50,000 per year should not spend more than $1,250 a month on rent or roughly $1,000 on mortgage payments considering all the additional costs of homeownership.

As for transportation costs, the best way to keep those to a minimum is to live car-free but this is certainly not a reality for everyone. We own two cars but we never had a car loan, never paid a premium for a brand new car, nor do we ever live hours away from work.

Try to buy slightly used cars and buy only what you can afford, not what the dealership is ready to finance for you. Pay cash and know that depreciation is a true cost that is often overlooked but cannot be ignored.

To keep your food costs low, learn how to cook and make lunches instead of eating out all the time. By shopping for fresh produce and quality meats, you can easily prepare restaurant-quality meals for a quarter of the cost.

Finally, keeping a healthy emergency fund is crucial to reach financial stability. The first step is to have enough in your checking or savings account to cover 1 month of expenses plus $1,000 as a buffer for unexpected emergencies.


Stage 2: Financial Stability

Once you are comfortable with this, you can increase your savings to  3-month’s worth of expenses. We suggest using online savings accounts like CIT Bank to get better returns on your money.

Having healthy savings and being able to respond to the curve balls life throws at you makes you financially stable.

At this point, or slightly earlier, you can start investing for your future self. Start with any free money offered out there. If your employer offers an RRSP (401k) with a match or an employee stock purchase plan, jump on the occasion.

Using low-cost index funds and tax-advantaged accounts puts all the chances on your side to grow your wealth and reach financial freedom.

Just to give you an idea, over the last 20 years, $10,000 invested in an S&P 500 index fund would have grown to $65,225 after a 0.05% annual expense ratio. The earlier you start, the better.

This is also a great time to start taking small risks with your time. You can start a side-hustle or participate in the sharing economy to start making a little money on the side. Start a blog and share your passion with the world or start a Youtube channel. Who knows, you might be the next big star and fast-track your progress.


Get a grip on your finances


Stage 3: Debt Freedom

This stage is about freedom. The freedom from creditors and the burdens of high interest.

If you have student loans, car loans, or credit card debt, now is the time to dump much more than the minimum payments and get those paid off.

For student loans, consider getting a lower rate through companies like SoFi if you did not already refinance your loans. Unless your rates are ridiculously low, increase your payments to pay them off faster.

For car loans, depending on your car, you could always downgrade to a car you could afford to pay up front. It might not be as new or as nice but it will get you where you need to go without breaking the bank. Over a five year period, a 5% interest rate means that about 12% of the monthly payments go towards interest. This really adds up over time.

If you accumulated credit card debt, you can uses services like SoFi to consolidate at a much lower rate or use repayment methods to get rid of that high-interest debt ASAP.

There are a few debt repayment methods out there, we will cover two super-efficient ones today. The Snowball method consists of listing all of your debts in order of smallest to highest dollar amount and then using any extra dollar to pay off the smallest balance while only paying the minimums payments on the others. Continue to do this until all of the debts are paid, the largest being the last one to go.


Source: Tempss co-lab


The other popular repayment method is the Debt Avalanche., For this one, list your debts in order of highest to lowest interest rate, regardless of the dollar amount of the debt, and pay the highest interest-rate debt as fast as you can. Continue to do this until all of the debts are paid, the lowest interest rate being the last one to get paid.

This method makes more sense mathematically but like anything money, psychology plays a big role in your debt repayment journey.

The Debt Snowball offers faster results since you will pay off the smaller balances first but the Avalanche method will pay off the totality of your debts faster.

To complete this stage, most people will still keep good debt such as a mortgage,  super-low interest-rate loans, or business loans. Anything that would hinder your financial independence, however, should be paid off.

Investments should also become a greater focus. You should try to max out your tax-advantaged accounts such as RRSP (401k) and TFSA (IRA). Automating everything with companies like Wealthsimple is super easy. Another way to start investing is with brokers such as Ally or Vanguard to keep your fees to a minimum but these are more DIY. If you have any more money to invest, you can even start investing in a non-registered account.


Start your financial journey


Stage 4: Financial Security

Once your investment portfolio has grown enough, there will be a stage where your basic living expenses will be completely covered by your investment income. Now, whether you work or not, the bills can get paid and you can survive layoffs or job switches.

At this point, you have security but a change in your income would still affect your lifestyle. To get to this stage, and to keep growing, your savings rate should be high in the double digits by now. We save over 50% of our income and keep our spending low to keep this savings rate as high as possible.


Stage 5: Financial Independence

When your investment portfolio can safely support your current lifestyle with a safe withdrawal rate within your risk tolerance, whether 3%, 3.5%, or 4%,  then you have reached financial independence. This represents 25 times your current spending (using a 4% withdrawal rate) so a $1,000,000 stocks and bonds portfolio would be needed to support $40,000 per year of spending.


It is appropriate to advise […] a stock allocation as close to 75 percent as possible, and in no cases less than 50 percent. – William P. Bengen


For the 4% rule to work, your stock allocation should stay quite high, even once retired. We covered this in the past and discussed different portfolios but personally, we hold 95% stocks with only a 5% bonds allocation. You can see our exact asset allocation in our Open Book series.

At this stage, you can retire or work on projects you are truly passionate about without worrying about the income they generate, or not.


Stage 6: Financial Freedom

Now, these last two stages are where things get interesting. Financial freedom is when you can actually afford more than your current lifestyle permits.


This might be things you desire to buy, experiences you desire to have, or philanthropic goals you wish to meet. – Joshua Sheats


At this stage, you are no longer restrained to such a strict budget and you can spend a bit more on things that truly make you happy. This might be attained by working, even after reaching financial independence, great investment returns, or income generated by one of your projects.


Master your finances


Stage 7: Financial Abundance

At this point, you have accumulated more wealth than you need to fund your lifestyle expenses and have a comfortable margin of safety. This would be the case of successful bloggers who started out as a fun project but who are now making hundreds of thousands of dollars per year or entrepreneurs who become hugely successful. By then, you must enjoy what you are doing, otherwise, there is no reason to keep working at it.

Hopefully, one day, we will all reach financial abundance but there is much work to be done.

Everyone can do it, just conquer one stage after the other and never look back. Stay constant with your personal finances and try to constantly grow. Best of luck, Xyz.



6 replies on “The 7 Stages of Financial Independence”

Nice breakdown! And great job at saving more than half your income!

We’re at stage 6 and we’re using a bit less than the 3% safe withdrawal rate. We’ve also gone conservative in our stock to bond ration (40/60). In the first few years of retirement we don’t want to erode the nest egg since there may not be time to recover.

Nice article… I do wonder though whether stage 2 and 3 should be reversed? Seems debt freedom leads to financial stability and focus on investing. Though I’d say increasing emergency fund to three months would still stay in stage 2 (with paying off debts).

Unique post! By implementing the initial six steps, anyone can do everything in his/her power to control financial abundance. Yes, faith is required for keeping away doubts and fears of the unknown and the uncontrollable future from becoming overwhelming.

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