8 Stages of Financial Independence

Stages of Financial Independence – 8 Steps to Freedom

As you pass through your life, you inevitably find yourself at different stages of financial independence. Some stages you might pass through quickly, some drag out for years, and still others you may never achieve.

If you want to control your money life, you should be able to quickly recognize which stage of financial independence you are currently in. The opportunities and priorities in your life will change depending on which level you are currently at. Be intentional and you can move through to the higher levels.

As ever, we are all different. What matters to you may be different to what matters to me. By understanding where you are at financially and where you are heading, you can make better decisions about the nexts steps fo your life.

The 8 stages of Financial Independence

The 8 stages of financial independence - Dependence, Survival, Solvency, Stability, Investing, Security, Independence, Freedom

1st Stage – Financial Dependence

There are only two certainties in life. Death and bills. Whilst your breathing, money is being spent on your behalf to buy clothes and food and shelter.

A person who is financially dependent relies on others for their financial support.

This means somebody else is paying your bills.

Rely on others for financial support


So who’d be crazy enough to dedicate their money to keeping you warm and happy? Family, Government and Charity.

Most commonly, its parents. You are born into this world with nothing. You are completely reliant on the kindness of others. They pay for everything you need. The clues in the definition – you are legally their dependents.

As you get older, you realize your family doesn’t have a magic money tree. More than likely they work to pay your bills. At some stage, you will need to stand on your own two feet. Maybe even eventually support them.

The government also provide a safety net for those who can’t rely on themselves. Social security payments, care for the elderly and state pensions. These are all examples of financial dependence. If you are relying on the government to support you, you are dependent.

Lastly, charity may be there to support those who have no means of supporting themselves. Food banks, shelters etc.

Whilst it’s wonderful that family, state and charity are there to catch those who can’t help themselves, it’s not sustainable. Financial dependence means somebody else is making a sacrifice for your benefits. You parents work to feed you, the government taxes people to support you, charities take from generous benefactors to five you support.

As soon as you are able, you need to move beyond dependence on others. You need to earn an income.

2nd Stage – Financial Survival

Starting to earn an income is such a major milestone in a persons life. Sometimes, it’s not celebrated enough. It’s a key turning point in the stages of financial independence.

Earning an income means you are doing something in exchange for money. But if you aren’t earning enough money to pay all you expenses, you are only financially surviving. Fighting to keep your head above water.

Many people start earning an income that’s less than their expenses. That’s how to transition from financial dependence. It’s quite likely that for your first job, you continued to live with your family, or had income support from the government.

When you are fully financially dependent, you are giving nothing in return. As an income earner, you have some cash to contribute towards your own survival.

This is when people get Saturday jobs, or work nights whilst they study.

It can also be where you are are earning but having to borrow to keep up with your expenses. This might be a deliberate plan, like taking a student loan to invest in your future. Or it may be because you can’t cover your expenses.

You often switch dependence on family to relying on banks to fund your lifestyle. Unlike your family, when you take a loan the bank expects you to pay it back!

Eventually, you are earning enough that you are no longer dependent on your family and society to support you. You’ve become financially solvent.

3rd Stage – Financial Solvency

When you are financially solvent you are able to pay your debts as they fall due. In other words, you can cover your expenses and debts as they fall due to you with the income you are earning.

Solvency is the “ability to pay all legal debts.”


For many, this will be their first full time job. By then you may have built up student loans or credit card that you need to pay off. But the money coming in means your able to get to the end of the month without having sunk into more debt.

In essence, financial solvency means your income equals your expenses.

For many in life, reaching financial solvency is the bare minimum to live without support from others. But as you earn more and take control of your finances, you may reach financial stability.

4th Stage – Financial Stability

Financial stability mean you have stepped beyond mere solvency. At the end of the month, you have more money than just enough to cover your bills

You have become a saver!

Saving is actually a passive act. It is the art of earning money and not spending it. To be at the forth stage of financial independence, you must have more income than your expenditure.

Even if you are keeping only $1 more than you earned, you are financially stable. Like the old line from Charles Dickens Mr Micawber:

Annual income twenty pounds, annual expenditure nineteen pounds nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

Mr Micawber, Charles Dickens.

There are choices available when you reach this milestone.

A choice that many make is to spend more. In other words, they realise they have saved money so they up their consumption. That could be on new shoes, nicer wine or a bigger house. Sometimes known as money creep, your spending inflates to absorb all the money available.

If you are suffering from money creep, bad news. You immediately drop out of stage 4 and move back down to stage 3. You are only financially solvent. Any disasters or surprise bills could tip you over until you are only surviving or maybe even dependent on others.

There is an alternative. That is to not increase your spending to match your income. That means you keep hold of your money. You are saving.

Many people in this stage use this opportunity to build up an awesome emergency fund. This gives them money to rely on in future, in case there is a surprise cost in the future. (And there are always surprise expenses – that’s life!)

Building up an emergency fund of three months or more expenditure will protect you from a short-term loss of income (like losing your job) or from big costs.

As time goes by in stage 4, you will start to build up your savings. You may even pay off debts that aren’t due until the future like overpaying a mortgage or paying down student loans. Your net worth will turn positive. You’re starting to really get control of your money.

So, you’ve come this far. Why are you not rich? Because all the money you earn is from your hard work. The function is effort in, money out.

The next stages of financial independence change this paradigm. You are not simply working to earn, your money is working for you.

5th Stage – Financial Investing

Once your emergency fund is in place, and you are consistently earning more than you are spending, it’s time to invest. This is the next of the stages of financial independence.

Whilst saving is simply keeping money you earn, investing is using that money to make more money!

In essence, a financial investor has started “buying” assets with the intention of earning a return over time.

The return on your investments can be from interest, or dividends, or captial gains. Your money could be in a bank account or holding shares or bonds or fine wine or foreign currency or even Bitcoin. The key is that your intention is to keep money to make money.

As time goes by, thanks in part to the magic of compound interest, you will find your net worth increase and even accelerate.

Eventually, you will be financially secure.

6th Stage – Financial Security

You are financially secure when you can survive any planned or unexpected change in your financial circumstances.

The state of being secure – free from danger, free from fear, free from the prospect of being laid off.


Someone who is financially secure has a bunch of strategies available if there was an cut in their income or a big jump in their required expenditure:

  • Build up multiple streams of income able to generate passive and active cash
  • Hold insurance against the biggest risks to health, home and security.
  • Keep trained and marketable to future employers.
  • Have income and returns coming in from invested assets.
  • Limit future expenses by paying off costs today – like mortgages and car loans
  • Know options to reduce spending in an emergency situation.

In essence, your financial investments cushion you from risk. The more money you have set aside, the more security you have. If you supplement this with insurance, then you are even better protected.

You know with confidence that if you lose your job, you have the money to cover your lifestyle whilst you find another job.

So, you may be wondering why financial security isn’t financial independence. The answer is simple – one of you strategies for financial security is to take another job. If you need to take a job, you are not financially independent.

7th Stage – Financial Independence

You are financially independent when you are able to cover all your future expenses from the asset you have invested today.

For many, this is the dream – the greatest achievement in the stages of financial independence. That’s why it’s took it’s name from this stage.

It is possible to use financial independence to retire early. But that is a choice. You could equally keep working, or change careers. With the stages of financial independence, the choice is entirely yours.

The simple formula for financial independence is to multiply your annual expenses by 25. If you have invested assets above that number, you have achieved the stage of financial independence.

As an example, Jay has annual expenses of $40,000. 25 multiplied by $40,000 equals $1,000,000. Provided Jay has invested assets of at least $1,000,000, he is financially independent.

Good news for Jay. He just received a bonus from work and invested it. He’s now got $1,000,001 invested. He has reached the 7th stage of financial independence.

Like any of the stages detailed here, it’s possible to fall back from stage 7. If change your spending patterns, or have bad insurance, it’s possible to lose financial independence status.

So is Financial Independence the final stage of this money journey? Not quite. This isn’t the seven stages of financial independence. There is one more step. And that is financial freedom.

8th Stage – Financial Freedom

Financial Freedom is Financial Independence dialled up to the max. Not only are you able to cover your day-to-day living expenses from your assets, you have extra returns. This means you can choose to spend more, if you want.

When you are financially free you have sufficient resources to choose the life you want to lead.

In technical terms, any assets you hold beyond those needed to be financially independent are par of your freedom fund. You could spend all of that money today, and still be financially independent.

Financial freedom is an insurance blanket protecting your financial independence. FI relies on assumptions about your future investment returns and your future expenses. Even the most cautious predictions of the future can prove to be wrong. Holding assets well in excess of the level needed for financial independence gives you more security to relax.

An alternative way to calculate this is to see what higher level of expenditure you could have versus your current annual costs.

Following the example of Jay that we started in Stage 7 – Financial Independence above. Jay has assets of $1,000,000 and annual expenses of $40,000. Using the simple financial independence calculation, Jay has 25 times his annual expenses so is financially free.

Take your invested assets and divide by 25. This gives you an approximate estimate of how much you could spend each year.

So, let’s say Jay has $1,500,000 in assets. $1,500,000 divided by 25 = $60,000. Therefore, Jay’s current life style costs $40,000 a year. But now Jay has a choice – he could spend $60,000 a year. That’s an extra $20,000 or 50% more than his current outgoings.

This is financial freedom. Jay is earning enough return from his assets to be free to choose to do new, different, more expensive things.

He is financially free!

And you could be too.

Stage 8 - Financial Freedom. Be as cool as this pineapple.

What’s next for the stages of financial independence?

The purpose of setting out a list of stages like this is not for academic fun. It’s to help you take charge of your finances.

Be sure to determine which stages of financial independence you are currently at. If you are in the early stages, do everything you can to boost your income and control your expenditure.

Later, make sure you are investing wisely for the long-term.

And if you have reached stage seven or eight – you financially independent or financially free, congratulations! Enjoy your life.

Remember, that just because you’ve reached a certain stage, that doesn’t mean you will stay there forever. You can continue to climb, or bad habits and bad circumstances can result in your falling back to earlier stages of financial indepednence.

Now, if you’ve come this far, you may be hungry to progress further. If so, it’s time to learn the ten steps to financial freedom.