Just for a moment, close your eyes and imagine the feeling of complete financial independence.
Like you, I am driven by the notion of reaching total financial independence within my lifetime.
Devoting oneself to this goal requires sustained effort and discipline.
However without a solid understanding of the path that leads to financial independence, your journey may turn into a lifelong scenic detour.
Goal Setting – What does Financial Independence mean to you?
The concept of financial independence resonates with everybody on an emotional level, but without having a clear vision for what this means in your particular situation, it is hard to
a) stay motivated over a long-term,
b) prioritize your alternatives, and
c) recognize when you have achieved your goal.
Much like the donkey chasing the proverbial carrot, loosely defined goals have a way of staying on the periphery without allowing you to ever feel like you are making any progress.
I consider ‘Financial Independence’ as reaching the point where my sustainable passive (i.e. non-employment) income covers all of my living expenses without depleting my savings.
I will recognize when I have reached this point because the goals I have set for myself are SMART:
- Specific – goals need to be clear and unambiguous. Specific goals have considered ‘who, what, where, when and why’.
- Measurable – you need to be able to track your progress.
- Attainable – aka the sanity check – goals should be ambitious but ultimately attainable. Try not to censor yourself on what could be possible, but don’t get so far ahead of yourself that you set yourself up for failure. To ensure a goal is attainable, you must be able to articulate ‘how’ you will go about meeting your objective (ie establishing passive income streams online).
- Relevant – is your goal worthwhile and what priority do you give to it? This is important when considering other opportunities that will undoubtedly arise. If a competing goal is to own a 60-foot sailboat, it would have implications for your financial independence goal.
- Time-Bound – to create a sense of urgency, well-articulated goals need to have an expiry date.
- Sample SMART goal: I will achieve complete financial independence before my 45th birthday. I will own a clear-title waterfront home in ·, have an investment portfolio of $· million and passive income sources (real estate, bonds, online and royalties) of $·/yr.
The 9 Stages of Financial Dependence
Once you have determined where you want to go, you need to recognize where you are on the path.
Do not sugar coat this determination.
For illustrative purposes, there are parallels between the 9 stages of financial dependence and filling of a bath tub where the tap represents your income, the drain represents all expenses and the overall water level represents your net worth (ie assets minus debt).
If your drain is larger than your tap, you will never be able to fill the tub.
To fill the tub to a comfortable level, you need a positive flow (ie income exceeding expenses).
a) how your current income compares to your living expenses and
b) how your assets compare to your debt, and then plot your current stage on this table:
Irrespective of your current stage, your strategy for climbing into the upper right hand corner is to generate more passive income, curtail spending and invest wisely.
Financial Independence – the Promised Land. This is where we should all aspire to be.
Starting to Build a Nest Egg – You are on track for Financial Independence and just need time to allow your investments to grow.
Paying down Debt – Inhabitants of this segment are making inroads on paying off creditors and are doing things correctly. They just need time to continue generating surplus cash flow before they move into Building a Nest Egg.
Freedom 65 – People with a positive net worth but who are spending their entire income are likely to continue working until they reach the mandatory retirement age. If their net worth is substantial, obviously an earlier retirement is possible.
Treading Water – This is a neutral position. Those in this segment are neither moving forward nor losing ground.
Financially Dependent on Employer – having lived through an unexpected job loss in 2010 (and eventual sale of my house in Florida at a loss) taught me that I should never leave my financial destiny in the hands of another.
You owe it to yourself to put new sources of passive income in place and limit your spending in order to pay down debt.
Lifestyle Depleting Savings – Depending on age, this stage may be appropriate for retirees who have sufficient savings to fund their lifestyle.
For non-retirees, a conscious decision needs to be made as to whether the current lifestyle is more important than achieving Financial Independence.
Cracks in the Foundation – a transitory stage where inhabitants can improve by curtailing their spending (move to Treading Water), or worsen by taking on debt to fund their excess spending (move to Tailspin).
Financial Tailspin – with the bathtub analogy in mind, in this stage the tub is empty and the drain is larger than the tap.
This is an extremely stressful stage where excess spending results in high credit card balances and late bill payments.
Possible prior debt consolidation loans further limits available cash.
Ways to exit this stage include credit counselling, debt renegotiation, debt consolidation loan, seeking higher paying (or second) job, austerity spending and establishing passive income.
Having a plan and recognizing how to move toward that plan are crucial in achieving Financial Independence. It is worth reviewing your plan on an annual basis and making adjustments to make sure you remain on course.