The six phases of financial independence
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The term “financial independence” has many meanings to many people.
To some, it means not working at all.
To others, financial independence covers all needs and many wants.
To others still, it means the ability to work on your own terms.
Where do I stand on this subject?
This post will tell you in my six phases to financial independence.
Retirement should not be the goal, financial independence should be
Is retirement your goal?
To stop working altogether?
While I think that’s fine I feel the traditional model of retirement is outdated and quite frankly, not very useful.
As humans, even our lizard brains are smart enough to know we need a sense of purpose to feel fulfilled. Working for decades, saving money for decades, only to come to an abrupt end of any working career might work for some people but it’s not something I aspire to do.
With people living longer, and more diverse needs of our society expanding, the opportunities to contribute and give back are growing as well. To that end, I never really aspire to fully “retire” – cease to work.
Benefits of financial independence (FI)
In the coming years, I hope to realize my desired level of financial independence.
We believe the realization of FI will bring about some key benefits:
- The opportunity to regain more control of our most valuable commodity: time.
- Enhanced opportunities to learn and grow.
- Spend extra money on things that add value to your life, like experiences or entrepreneurship.
Whether it’s establishing a three-day work week, spending more time as a painter, snowboarder, or photographer, or whatever you desire – financial independence delivers a dose of freedom that’s hard to come by otherwise.
More succinctly: financial independence funds time for passions.
FI concepts explained elsewhere
There are many takes on what FI means to others.
There is no right or wrong folks – only models and various assumptions at play.
For kicks, here are some select examples I found from authors and bloggers I follow.
- JL Collins, author of The Simple Path to Wealth, popularized the concept of “F-you money”. This is not necessarily financially independent large sums of money but rather, enough money to buy a modest level of time and freedom for something else. I suspect that money threshold varies for everyone.
- Various bloggers subscribe to a “4% rule”* whereby you might be able to live off your investments for ~ 30 years, increasing your portfolio withdraws with the rate of inflation.
Recall the rule:
*Based on research conducted by certified financial planner William Bengen who looked at various stock market returns and investment scenarios over many decades. The “rule” states that if you begin by withdrawing 4% of your nest egg’s value during your first year of retirement, assuming a 50/50 equity/bond asset mix, and then adjust subsequent withdrawals for inflation, you’ll avoid running out of money for 30 years. Bengen’s math noted you can always withdraw more than 4% of your portfolio in your retirement years however doing so dramatically increases your chances of exhausting your capital sooner than later.
In some ways, the 4% rule remains a decent rule of thumb.
For simplistic math, your “FI number” could be approximately your annual expenses x 25.
So, if you’re annual expenses are about $40,000 per year (CDN $ or USD $ or other), then your “FI number” is a nest egg value of $1,000,000.
Are there levels of FI?
For some bloggers, the answer is “yes”:
- Half FI – saved up 50% of your end goal (e.g., $500,000 of $1M).
- Lean FI – saved up >50% of your end goal; income that pays for life’s essentials like food, shelter and clothing (but nothing else is covered).
- Flex FI – saved up closer to 80% of your end goal (e.g., $800,000 of $1M). This provides financial flexibility to cover most retirement spending including some discretionary expenses.
- Financial Independence (FI) – saved up 100% of your end goal, you have ~ 25 times your annual expenses saved up whereby you could withdraw 4% (or more in good markets) for 30+ years (i.e., the 4% rule).
- Fat FI – saved up at or > 120% of your end goal (in this case $1.2M for this example), such that your annual withdrawal rate could be closer to 3% (vs. 4%) therefore making your retirement spending plan almost bulletproof.
There is this concept about “Slow FI” that I like from The Fioneers. The concept of “Slow FI” arose because, using the Fioneers’ wording while “there were many positive things that could come with a decision to pursue FIRE, but I still felt that some aspects of it were at odds with my desire to live my best life now (YOLO).”
They went on to state, because “our physical health is not guaranteed, and we could irreparably damage our mental health if we don’t attend to it.”
My six phases of financial independence
With a similar line of thinking related to Slow FI, since we all have only one life to live, we should try and embrace happiness in everything we do today and not wait until “retirement” to find it.
(Picture from our catamaran cruise, Barbados 2019)
After reviewing these ideas above, among others, I thought it would be good to share what I believe are the six key phases of any FI journey – including my own.
Phase 1 – FI awakening. This is where there is an awareness or at least an initial desire to achieve FI even if you don’t know exactly how or when you might get there.
FI awakening might consider self-reflection questions or thoughts like the following:
- I would love to retire early or retire eventually…
- I can never seem to get off this credit card treadmill…
- I wish I had some extra money to travel…
- Wouldn’t it be nice to buy X guilt-free?
(I had my awakening just before I decided to become My Own Advisor, triggered by the financial crisis of 2008-2009.)
Phase 2 – FI understanding. This is the phase where people are getting themselves organized; they start to diligently educate themselves on what their personal FI journey might be.
In this phase, they might set goals or get a better handle on what goes into their financial plan. Even if your plan is not perfect, it’s a start.
They might start asking some deeper questions like:
- Why is money important to me?
- What is my money for?
- How do I know I’m doing it right?
(I would say it took me until my mid-30s to get my financial life in order through more financial education and improved financial literacy. It was a process that took a couple of years although I’m always continuously learning and improving. I don’t pretend to know it all.)
Phase 3 – FI funding. In this phase, people start to realize some financial stability. Maybe the emergency fund is now fully established. Usually an approach to long-term investing has been solidified. More than likely for younger investors, student loan debts are being put to rest. In phase 3, debt management is under control. Sure, you might have a mortgage or maybe even a car loan but by this phase you’ve learned to manage your financial behaviour for the better.
Maybe you’ve already made the crucial decision to become debt-free first or invest first.
The FI funding phase also means you’ve taken steps to start optimizing your financial life – reducing waste and excess. It’s doesn’t mean you’re perfect but you do start to align your spending with your financial values. You’ve already started to automate any savings for investment purposes. This will accelerate your path to financial independence…
(In writing about my own FI funding experiences, my wife and I really upped our FI journey once we landed on our two-pronged investing approach: owning a basket of dividend paying stocks for growing income AND continually buying more low-cost ETF units for long-term growth. This was an investing approach we know we could stick to for the long-haul – and still do.)
To pause here, phases 1-3 are really about financial organization.
Phase 4 – FI adoption. This phase is where routine, but often diligent combinations of debt repayments + investing are occurring over time. Somewhere early in your FI adoption phase, probably in your 20s and 30s, you’ve embraced the merits of having a cash emergency fund. In phase 4 however, beyond cash savings, you now also have investments in the bank to ride out any major financial storm for multiple months or quarters, or maybe even a few years. In this phase, most of your financial plan is complete and you’re sticking to it. Things seem like they are on autopilot. You spend little time sweating the small stuff financially.
With your FI brain fully engaged, you’re actively executing on your FI plan. There is no longer any second-guessing about what to invest in or why. You’re engaged. Ideally you’re not rattled by the stock market noise. You’ve learned to tune out financial experts who think they can predict the financial future. (Newsflash: they can’t!)
Admittedly, because “I’m here” in this phase, I can tell you this is absolutely the longest one.
The growth curve feels like it’s taking forever. Yet looking back, it’s tremendous to see how far we’ve come.
Now that you’ve fully adopted your FI journey, you realize achieving your goals while simple is not easy.. It takes multi-year discipline but you are absolutely getting there…
And the good news is – you know the formula by now:
- Save early, save often. Maintain a modest savings rate.
- Automate your savings for wealth-building.
- Diversify your investments, although own mostly stocks over bonds.
- Minimize your investing costs.
- Rinse and repeat until wealthy.
(My wife and I have determined that sometime in the coming years, we should be financially independent. I’ll keep you posted of course!)
Phase 5 – FI security. This phase is where your basic living needs (home expenses, groceries, other small necessary items like insurance) are covered by the cash flow from your investments (the combination of distributions, dividends, interest, or selling some assets as needed) and/or from passive income sources like rental income or royalties.
FI security doesn’t offer you cash for life, but it does cover many basic needs associated with it.
Based on how much you might have saved and invested, you could likely live a frugal existence for the coming decades. FI security is on the edge of full-on financial independence.
(My wife and I aren’t there yet but we are getting close to realizing this phase. For example, I calculated if we have no debt, we’d be in this phase now. We’re optimistic that dividend income (without selling any assets) from our non-registered portfolio alone should cover our condo property taxes and our condo fees for life – sometime next year. Those expenses are estimated to be in the range of $12,000 per year. Those expenses will likely increase with inflation over time. We’re optimistic that dividend raises from the companies we own will help offset those inflationary costs.)
FI security equates to a financial Crossover Point.
The Crossover Point was popularized in the book Your Money or Your Life. This is the point whereby investment income matches or ideally exceeds common monthly expenses on a consistent basis. Reaching your personal Crossover Point means you have a steady income stream for life.
Phase 6 – FI freedom. You’ve made it! This is what I consider the final phase in my FI journey where truly all expenses (basic and discretionary) are covered by existing and more than likely growing assets (if you did not significantly draw down your portfolio at all).
There is no need to work at all, although some people may choose to do so for social, physical, mental and other wellness benefits. (I intend to.) Some of these wellness benefits even escaped a financial classic that sold millions of copies – The Millionaire Next Door.
As part of your FI Freedom Day, the income delivered to you from your investment portfolio covers everything you need and maybe a little bit more. At the frothy end of financial independence, you might have FI surplus – an abundance of cashflow whereby you can be more philanthropic to causes or events that make a positive contribution to the lives of others. Also at the top of end of FI, you might have a tax problem to navigate – how to draw down your portfolio you’ve worked so hard to accumulate.
Oddly enough, you might not even be debt-free when you reach your FI Freedom Day. This is because you could readily pay off any liabilities (e.g., rental properties) without any long-term financial consequences.
When you reach FI freedom, you’re a money savvy pro. You’ve been so effective and efficient at your financial management plan for so long, financial literacy is now part of your DNA.
The six phases of financial independence summary
When it comes to money management I’m convinced if you work through my six phases of financial independence, whatever you call your FI journey, I suspect you’ll find what you’re looking for at whatever pace you wish.
Happy saving and investing.