There are various stages on the journey to financial freedom. We all start with very little to no freedom. Then our amount of freedom increases as we progress through the six levels of financial freedom.
Most people start the journey without even realising it. Or they start on it to have money to spend to buy the things they want and do what they want to. The problem is that they don’t ever get to the finish. Instead they get distracted and lose their way. Usually because they are unaware of the path and the levels of financial freedom. They end up completing part of the path but not the full one.
Financial freedom or financial independence is not a common concept, but being rich and retiring are. I always understood the concept of being rich and retiring and not working anymore. My problem was I did not understand how to achieve these goals. I thought you had to be lucky and one day you would have this wealth and freedom or you had to be born into a family who already had this. Or alternatively, you had to work for 40 years and then it would just happen.
Financial Freedom is a Journey
The reality is that financial freedom is a journey with levels that you work through to achieve. Every milestone or stage of financial freedom adds another level of freedom. If you think about your own life you must have experienced some of these levels. If you then think about it you will realise that achieving a certain level gave you some freedom.
When you think about financial freedom in this way it makes understanding and achieving financial independence possible. Every step of the way you will feel more motivated and understand how it can change your life. You also understand that it is less about having the money and more about having the freedom and peace of mind that the money gives you. You also begin to understand that it will not happen by itself or bring happiness in itself.
Level 1: Earning an income
The first step that all of us experience is earning an income. That feeling that you get when you receive your first pay check is memorable for all of us. It is your first taste of looking after yourself and being free from whoever had been providing for you until that point. This is the first of your levels of financial freedom.
Once you start earning an income it gives you the freedom to do more. You can buy more, you can live somewhere different and you can do different things. It is great to have this freedom of choice. The problem is that with freedom comes responsibility. The more freedom you have the more responsibility you have to use it properly.
The other option you have when you start earning money is to invest the money but this is the least exciting and rewarding option for a first time salary earner. It is much more fun to buy the things you have always wanted and to and have fun with your friends.
Earning money is the most significant first step to freedom but it is also the most significant in carrying you all the way through to financial independence. Arguably if you earn a huge amount of money you can almost skip a few of the stages and go all the way to the end. That only happens to lotto winners. But then you can just as easily fall all the way back to the beginning which happens.
Instead you want to understand how to create financial independence yourself in such a way that it changes your life and lasts forever.
The sad reality is that the majority of people never manage to move on from level 1. For people who experience poverty they only just earn enough to survive and find it very difficult to move on.
Then there are the rest who land up making bad financial decisions and living lifestyles above their means. This leads to a vicious cycle of earning more to spend more without ever achieving more freedom. In fact they lose some freedom because they have debt and commitments. The initial freedom they felt by having a disposable income is now gone as their money is spent before they even receive it.
Level 2: Eliminating debt
Debt is the consequence of the irresponsible use of that initial freedom that we get when we start earning money. Our desire to have more now without being patient until we have enough money leads us to incur debt.
Being in debt means that you owe someone else money and more importantly it means that you have lost some of your freedom. You have given someone else control over you. When you have debt commitments someone else is deciding what happens to your money. You have lost the freedom to spend the money the way you want to. Debt commitments can last up to 20 or 30 years for large purchases like houses.
Living in debt is the reality for the majority of people. Debt is an important tool and sometimes necessary for education or useful to buy a house for example. But it comes at the cost of your financial freedom. Some people manage to live a life without debt at all as they value their freedom so much.
People talk about good debt and bad debt and sometimes it is acceptable to be in debt for a period of time. This is a topic for another post. The reality is that debt takes away freedom. Only when you become debt free do you fully realise and understand this view. That is why it is one of the essential levels of financial freedom because without it you are not truly financially free.
Level 3: Emergency fund
The emergency fund is another powerful and essential level of financial freedom. It can come before or after you eliminate debt. The effect is the same, it is a matter of choice. The emergency fund is a sum of money that is immediately available to you in case of a financial emergency.
It can be for any financial emergency from something small like having an unexpected expensive repair on your car to losing your job. This emergency fund gives you that peace of mind. If something unexpected happens, you have a plan. Having that fund allows you to deal with the crisis without having to borrow money or sacrifice something else. This is important but there is another advantage. It gives you freedom.
The emergency fund gives you the financial freedom but also the mental freedom and confidence. This freedom gives you more options to choose what you want to do even without an emergency. Another term for emergency fund coined by JL Collins in “A Simple Path to Wealth” is FU money
A great example of having FU money is how you approach your job. With an emergency fund you may feel less desperate about keeping the job that you have and be more free to change jobs. It can make you feel less trapped in the situation. With FU money you know that if you really don’t like it you have time and resources to change without risking everything.
Like with debt it is only once you have an emergency find that you start to feel and understand the freedom that it beings you.
Level 4: Investing for freedom
If you can achieve just the first 3 levels of financial freedom your quality of life and freedom to choose will be significantly better. Once you have achieved these 3 levels you should be in a position to start investing. That is not to say you should not already have started investing. Infact you should have started off with tax free retirement investments from day one. But you would not have reached level four yet. When you have eliminated debt and have an emergency fund you can start to invest all your disposable income.
Once you start this process you will experience a significant and fast increase in your net worth. This is a common experience for all the people I have encountered on the financial freedom journey including myself. Without the drag of debt you are now on the positive side of compound growth. The combination of your monthly contributions along with the monthly investment growth builds wealth quickly. It will only take you a few years to build up a sizeable investment portfolio.
As this portfolio grows so does your financial freedom. You start to realise that financial independence is in sight and a real possibility. Every month you feel more and more free and have more and more options ahead of you.
You will still be heavily dependent on your earned income to be able to achieve financial independence. It is a significant level of financial freedom that you enter. You start to sleep a bit easier at night and feel more confident about your financial position.
Level 5: Realising Financial Freedom
This second last of the levels of financial freedom lies somewhere between investing and being financially independent. Financial independence is a specific number where your expenses are covered by passive income or you have enough capital to cover your expenses for the rest of your life. But there are many variables. The biggest one being what your expenses are. Because spending less or more will mean that you either have or have not reached financial freedom.
Realising that you have reached financial freedom comes down to a mental state. It is a point where you realise that depending on how you live your life going forward you could be financially free. Some people will take this opportunity by keeping their lifestyle very minimalistic in order to have that freedom now. Other people will want to take longer to build up more wealth to cover a more costly lifestyle.
So it turns out that achieving financial freedom is a moving goal post. What also happens is that people tend to want to work for another “1 more year” as they call it. It s a bit of a thing in the FIRE community where some people tend to keep on working longer than they need to just to be sure.
So even though you have a target number to achieve. That number will be ever-changing depending on market conditions your own expenses and your preferences. Either way there comes a point where you realise that you do have financial freedom. You may have had this realisation but you haven’t yet cut off that major source of income and you don’t have your full freedom yet.
Level 6: Time Freedom
The final and sixth level of financial freedom is when there is no doubt that you are infact financially free. This is normally after you have achieved it and have been living without all the income you once had.
At this point you are confident that the wealth you have created is sustaining itself. Mostly what seems to happen is that people still have some income coming in and they find that they are spending less than they anticipated. This results in a situation where your net worth continues to increase. Once this happens you are confident that you are financially independent.
Now have complete freedom to do what you want and go where you want to. You choose how you spend your days, which projects you do or don’t do. Money is not a concern because you can cover your expenses and needs for the rest of your life. You will no longer be reliant on spending your time to earn money.
That’s it you are there
These levels of financial freedom are like steps of a ladder to freedom. Each level allows you to take a step up into the next level of freedom. The final destination is not about the amount of money that you have. Instead it is about the amount of freedom that you have. The money gives you the freedom to spend your time how you choose. So financial independence is about having time. Money is the tool that you use to achieve that. Hopefully that time will allow you to only do the things that make you happy.