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How to Blast Through the 5 Stages of Financial Freedom

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Financial freedom means different things to different people.  We all come from different situations, so the formula for one person may not be ideal for another person. However, understanding the different stages of financial freedom is the first step to improving your financial position.

Financial freedom is the state of having enough income and personal wealth to quit your day job and spend the remainder of your life doing what you love. That doesn't mean you don't work – you may have a vocation or business that you enjoy.  You may have several income streams if you are a high achiever. Or, you may want to retire and do nothing and live only on the income of your investments.

Know Your Number

Do you know how much money you need to quit your day job? This number differs from person to person.

If you aren't sure how to calculate how much money you need to quit your day job, try a simple calculation:

Take your current annual income, and divide by 8%. For example, if you make $40,000 per year (gross pay), divide that by 8%, and you get $500,000.  Now you have a quick number to write down.  You may do research and decide on a different number later on, and that's fine.  But having a target amount of funds to save for gives you a goal.

Don't panic.  It looks like a big number, but you will be shocked how fast you can earn it as you begin using some of the methods that lead to financial freedom. Why do you need to know what amount of money you are working towards?

If you're working towards financial freedom, it will motivate you on hard days.  It will remind you why you're choosing not to splurge or buy that nicer car.  Write your number down and hang it on your wall or bathroom mirror.  You need to see it every day.

Not sure what your net worth is? This article from How-to Personal Finance will teach you how to calculate it.

Stages of Financial Freedom

There are 5 stages of financial freedom.  For each stage, I highlight key moves to make to blast through that stage and onto the next one.  Using these techniques will help you reach financial freedom faster.

Stage 1 – Buried Alive

This is where some of us start out. I was at this stage when I was a working single mom with an entry level job as a staff accountant. At Stage 1 – Buried Alive, your current income doesn't cover your current expenses.

Your current income includes your job, your spouse's job, or the job of anyone contributing to your living expenses. Current income also includes funding from any government programs, charities, or deductions to expenses for donated food, clothes, etc.

Your current expenses include your normal monthly expenditures, including fixed costs like rent/mortgage, utilities,

If your expenses exceed your income, you probably have a large amount of debt to pay off.  Your first move is paying off your unsecured and revolving debt.

Unsecured debt includes credit cards, signature loans, and medical bills. Revolving debt includes things like lines of credit and home equity loans (not including your mortgage).

To move to the next stage of financial freedom, you need to pay off all unsecured and revolving debt. Dave Ramsey says to start with your smallest balance and pay that off first, and then move to the next one.  It is called the Snowball method of paying off debt.

How can you afford to pay off your debt?

Make a budget and find ways to lower expenses. Sell everything you own that you can live without. Have a garage sale or sell it on Ebay.  Use the extra funds to pay down your debt.

If you are employed, kick ass at work. Volunteer for new responsibilities when you have an opportunity. New skills will be added to your resume and you can use them to qualify for other higher-paying jobs. If your current employer doesn't pay you more for the extra work, you can eventually move to a new job.

As an entry level accountant, that's how I found higher paying jobs.  I always said yes to new projects and duties. Read about how I tripled my salary in five years.

Key tips:

    • Calculate the amount of money you need to quit your day job.  Write it down and hang it on your wall or mirror. Boom – you have a long-term goal.
    • Make a budget – track your progress – don't waver.
    • Start paying off your unsecured and revolving debt.
    • Cut up your credit cards (except for your oldest credit account).  Bury that one in the backyard or something.  You only need to keep it for credit score purposes.  But never use it again!  At least not until you hit Orbit (stage 4).
    • Garage sale time – sell all your extra stuff.  Let go of your junk.  Sell it and use it to pay down your debt.
    • Kick ass at work!
      • Make yourself indispensable to your company
      • Treat your manager like a customer instead of an employer
      • Take on new projects without asking for more pay.  The money will come!

Stage 2 – Ground Zero

Stage 2 – Ground Zero starts when your unsecured and revolving debts are paid off, and you can afford your basic living expenses.  Now that you aren't paying credit card balances every month, you have some extra cash.

Your number one goal is to establish an emergency fund of cash.  Don't spend this money for any reason short of a LEGIT emergency.  

Starting an emergency fund is a big deal.  It means you are building wealth!

The ideal emergency fund can cover your living expenses for at least three months.  How much do you need for three months of living expenses?  It varies from family to family or person to person. Your budget will show you how much you need in cash to cover your expenses for 3 months.

For example, if you spend $3,000 per month on necessary expenses, then you need at least $9,000 in your emergency fund.  This might sound like a lot.  You don't need to save it all in one month.  Set a target and stick to it.

Start a side hustle.  A side hustle is a second income stream that keeps you from being 100% reliant on your day job.  Think about what you love to do in your free time, and do some research on how you can turn it into a side income.  That extra income will kick your progress into high speed and help get you to the next level of financial freedom faster.

Key tips:

    • Stick to your budget – track your progress every month – be relentless
    • Start your emergency fund
      • Open a High Yield Money Market account
      • Transfer funds into your money market account every pay day
      • Keep saving until you've saved up 3 months of living expenses
    • Keep kicking ass at work!
      • Step up and ask for more work
      • Volunteer for different tasks, but don't ask for more money.  The money will come!
      • If you've been with your company for more than a year and you can make more money at a different company with a similar or higher position, think about switching jobs
    • Start a side hustle – focus on hobbies or things you enjoy and start building a new income stream

Stage 3 – Lift-Off

You are officially in Stage 3 – Lift-Off when your income exceeds your expenses, your unsecured and revolving debts are paid off, and your emergency fund is full.  Great job on becoming financially stable!

Its time to grow your net worth.  Invest your retained earnings – that is, money you make and don't spend.

Start contributing to your company's 401k, especially if they offer a match.  A 401k match is FREE money to you.  If you are in your 20s-40s, you don't need to contribute 10-15% per year if you are actively building wealth outside of your retirement account.  If you're in your 50s or 60s and you don't have at least 75% of your target amount saved, you should be contributing the maximum allowed into your 401k.

There are schools of thought that believe you should always invest the maximum into your 401k.  I think it makes sense for three types of people:

  • High income earners who make enough money to grow their income streams AND also want to max out their pre-tax earnings.
  • Those of you out there who will spend your money unwisely.  Locking it away in a 401k saves you from yourself.
  • Individuals in their 50s and 60s who are retiring in the next 10 years and don't have the wealth they need to live off of post-retirement interest & income.

Some of you are responsible with money (or are learning to be), reasonably young, and don't have enough income to grow your post-tax wealth AND your 401k. Do you really want to tie up all of your wealth until you're 65?  What if you'd like to use some of it to invest in real estate or grow your side business into a legit income stream?

Locking away 100% of your wealth into a retirement account prevents you from being financially “free” until you retire.  Think about that for a minute.  You may not even live until you're 65. You have about a 75% chance of ever using that money.

Consider opening a non-retirement brokerage account, also known as a retail brokerage account.  Go to TD Ameritrade, Schwab or another full service brokerage and open an account.  Start making deposits and research how to invest and manage your risk.  Its this leverage that will send you to the next stage of financial freedom.

Get serious about your wealth creation strategy.  Not sure how to get started?  Read about the OSTT Framework, and learn how to develop your wealth creation strategy.

Key tips:

    • Stick to your budget – don't let lifestyle creep destroy your carefully-laid plans!
    • Start contributing to your employer's 401k program.
      • If there's a match, contribute enough to take advantage of that FREE money
    • Open an online brokerage account.
      • Transfer as much as you can from every paycheck into your brokerage account
      • Start investing in the stock market with ETFs, mutual funds, or individual stocks.  You can also buy bonds and invest in REITs with a full service brokerage.
      • Other investment options to consider are Lending Club (peer-to-peer investing), or CDs
    • Grow your income streams – focus on things you love doing

Stage 4 – Orbit

Once you hit Stage 4 – Orbit, you've “made it”.  Congratulations! You are in full control of your future and focusing your time and energy on things you love.  You now make enough money on your side income streams and investment income that you can quit your day job if you choose.  By now your net worth is around 50% or more of your target amount.

At this point you should know exactly what you want to do with your life when you quit your day job. You will want to focus most of your energy on scaling your income streams.  If you aren't monitoring KPIs and financial reports separate from your personal finances, now is the time to start.

Consider forming a legal entity such as a partnership or limited liability company (LLC) to protect your assets and separate your business from your personal net worth. Meet with a tax attorney and a certified public accountant to ensure your business structure is optimized for risk management and tax savings.

Key tips:

    • In addition to your budget, you should also be monitoring Key Performance Indicators (KPIs) and financial reports.
      • Consider building a KPI dashboard to monitor analytics
      • Review a profit and loss statement monthly to determine how your income streams are performing
    • Start scaling your income streams – consider hiring help if you are a solopreneur
    • Get more sophisticated with your business structure
      • If you haven't already, consider forming an LLC or partnership to separate your business from your personal net worth
      • Meet with a tax attorney and CPA to ensure your business structure is optimized for risk management and tax savings

Stage 5 – To the Moon!

Let's face it, most people never hit this stage.  Many will stop at the Orbit stage, and live the rest of their lives out merrily.  This stage is for those of you who want more.  You know who you are, Elon Musk.  You're building an empire. You're a high achiever, driven and successful.  Its to the moon and lambos for you!

Key tips:

    • Use an attorney and financial adviser to ensure your assets are protected.
      • Make sure you have the right amount of insurance coverage to protect your assets.
    • Prepare to leave a legacy – involve your family members in your decisions and in your financial values.
    • Make the most of irrevocable trusts, retirement accounts and education savings accounts that allow you to safeguard funds against tax penalties.
    • Pay yourself first. Don't leave all of your capital in your business. Diversify your assets.

Conclusion

The five stages of financial freedom –

  1. Buried Alive –  your expenses exceed your income and you're deep in debt;
  2. Ground Zero – your income equals your expenses and you've paid off your unsecured and revolving debts;
  3. Lift-Off –  your emergency fund is full and you're stockpiling savings;
  4. Orbit – you have enough money to quit your day job if you choose; and
  5. To the Moon! – you aren't satisfied with anything short of building an empire, and you're well on your way!

For thoughts on financial freedom from another personal finance blogger, MoneyRed Pill, check out this article: The Best Way to Get Your Your Dream Job? Invent it Yourself

Which stage of financial freedom are you on?

How to Blast Through the 5 Stages of Financial Freedom

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