What Does Achieving Financial Freedom Mean to You?
Remember the last time you bought a lottery ticket with the dream of winning big? Before the numbers were even drawn, you might have fantasized about how you’d spend your new fortune. Whether you realize it or not, a big part of that fantasy is conceptually being financially free, and the great news is you don’t have the win the lottery to achieve financial freedom.
What financial freedom looks like is different for everyone. For some, it might be financial independence from parents or a romantic partner. For others it might mean living a lifestyle where they don’t have to restrict themselves financially.
Even though all of our visions are different, and everyone’s path will vary a little depending on their own situation, there are some things we can all consider while trying to attain our dream.
5 Stages of Financial Freedom
At each stage of our path towards financial independence we find a new level of freedom, and it’s important to remember that these steps should be sequential. I want you to think about following these stages as a journey—this requires planning and there are no shortcuts—but by being thoughtful and effective with our finances, we may find ourselves progressing from one stage to the next faster.
Our journey starts with achieving freedom to handle the unexpected, then freeing ourselves from crippling debt, obtaining freedom to Go or get Let Go, then Freedom to follow your own path, and finally, financial independence.
Stage 1: Freedom to Handle the Unexpected
In stage 1 of our journey, we give ourselves the ability to handle the unexpected. By establishing an emergency fund, or cash safety net, we provide ourselves with protection from unplanned expenses or life events. This stage is vital as it can help provide a foundation which you can build on.
So how much do you need to set aside? The specifics will depend on your personal situation, but to start, a possible goal in this stage is to establish a cash safety net of approximately one month worth of expenses. This money may be most helpful if it is kept liquid and easily accessible, like in a checking or savings account.
Having cash on hand if your car breaks down or you have an unexpected medical bill will give you one less thing to worry about—which can help keep you on track when you’re in the later stages of the process—without derailing your financial goals.
Behind income, studies have shown that the one thing that impacts financial satisfaction the most is having enough cash on hand to cover emergencies. Sadly though, 39% of adults would have trouble paying a $400 unexpected expense. Having money set aside for a crisis can help you keep on track to your other goals without derailing your financial plan.
Stage 2: Free from Crippling Debt
Once we have our cash cushion, we can move on to tackling our bad debt. In my opinion, eliminating high-interest rate debt is one of the best ways to make your dollars work effectively. In order to do this, we first want to understand the difference between good and bad debt.
Some types of debt are good debt—these are your empowering debts that are helpful tools like student loans, mortgages, and car loans. Bad debt, on the other hand, is any high-interest rate debt at rates of 7% or higher, including credit cards, personal loans, and unsecured lines of credit.
In stage 2 we want to focus on eliminating all of our bad debt, but our good debt can be paid off as scheduled without accelerating payments. Bad debt has been associated with increased anxiety, stress, and even has an impact on health such as heart problems, loss of sleep, and even heart attacks. For both our financial health and our physical health we want to make eliminating our high-interest debt a priority.
Stage 3: Freedom to Go or be Let Go
Stage 3 is where we start to see our paths become a little more personal. While we all need an emergency fund, the amount that is appropriate will vary based on our personal circumstances. The idea of this fund is to last you through a period where income is lost, either voluntarily by calling it quits at a soul-crushing job, or involuntarily if your job winds up being eliminated. Want help determining how much is right for you?
With an appropriate emergency fund you can take risks such as leaving a job you hate or avoid bankruptcy if you lose your job. According to Bankrate, only 17% of Americans have three to five months worth of living expenses saved!
As a Financial Planner here at SoFi I speak with members about their finances everyday, and too often I hear from someone that they don’t need an emergency fund because they have plenty of job security. “I’m a software engineer living in San Francisco, I’m not worried about being unemployed” is a fairly common theme. It’s important to realize that an emergency fund is not just for losing your job, there are plenty of other emergencies we need to be prepared for.
Stage 4: Freedom to Follow Your Own Path
Here’s where we get to start having fun! If you’re interested in a sabbatical, career change, going back to school, or starting your own business, setting aside savings can provide more freedom to follow your own path. This is the stage where you get to think about your dream of financial freedom and start saving with a purpose.
Chances are you’ll need to save for a few year’s worth of expenses or have enough to live off of with significantly less income. If that’s the case, this is where we need to be more aggressive with our savings and invest our savings for growth.
Stage 4 is a step many people never achieve—not because it’s unattainable, but primarily because they don’t plan for it, or aren’t willing to make the sacrifices it takes to save for it. If you’ve decided that there’s a vision of financial freedom that you want to achieve, this stage here is how you will make it happen.
Stage 5: Financial Independence
Ultimate freedom! Being financially independent looks different for everyone, and what it takes to get here is personal. Maybe for you this means pulling back at the office and only working part-time so you can spend more time at home. Maybe it’s taking a job in a non-profit instead of the private sector, or maybe it truly is retiring.
Whether you’re currently on stage one or stage four, identifying what you expect you’ll need in the long run can be a helpful destination to set your sights on, as well as a way for you to gauge your progress on this journey.
Achieving financial independence means you’ve acquired enough money to let it work for you, and this is when fixed income becomes a more important part of our vocabulary. Chances are you’re not at stage 5 yet, but if you can estimate what you’ll need to live, you can determine how much you want to save in order to get there.
We may all have different visions of financial freedom and independence, but what we can do to get there is fairly simple. Our journeys are not always linear, and that’s okay, but an awareness of where we are in our journey and what we need to do to achieve our goals can help us continue to save and invest with purpose during our careers.
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External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
The opinions and analysis expressed here are those of Lauren Anastasio as of 9/13/19. These views may change as market, economic, and other conditions change. This information isn’t financial advice. Investment decisions should be based on specific financial needs, goals and risk appetite.