If you think of running a marathon as a two stage process – lying on the couch then getting up to run 42 km – chances are fairly high that you’re not going to make it around the block, let alone to the finish line.
Similarly, if you see the path to financial freedom as going from A (living from paycheck to paycheck) to B (being able to afford to do what you want, when you want), then you’re not even going to get past the first debt-soaked hurdle.
(Step 1 of achieving a goal is identifying just what that goal is!
So check out our post on Financial Freedom is Totally Achievable. Here’s How.)
Breaking down the journey
As discussed in an earlier article, breaking the journey down into multiple steps exponentially increases your chances of actually becoming financially free.
You will have much more achievable objectives.
There will be clear guideposts that will show you that you’re on the right track.
And you can rightfully claim every success that you have along the way.
Remember: you have to start somewhere
No one goes from zero to hero overnight.
And similarly, no one immediately starts saving 50% of their income (or more!) in one fell swoop.
Everyone starts small. First you work towards consistently saving 5%.
Then you figure out certain ways to save more money and increase this to 10%.
You acknowledge that there are certain things in life that you can live without and work up to 20%.
Suddenly, you realise that you value having the option to do what you want more than having the newest gadget and, before you know it, you’re at a
saving rate profit margin of 50%.
Interestingly, the increase to your saving rate will likely align with the process that the rest of your finances are taking at the same time.
By this, I mean the following: when you start to learn how to save, and realise just how amazing the benefits are, it’s very likely that you’ll quickly realise how you can save even more by spending even less. This will continue to accelerate both the increase in your saving rate and, consequently, the speed of your progress along the path to financial independence.
The road map to financial freedom
Each step along the path to financial freedom can roughly be broken down as set out below.
Treat this as rungs along the ladder. It can take a hell of a lot of effort to pull yourself up to each level and it’s good to take a breather once you make it to each one.
But then you see the next one just out of reach and you know the view will be even better up there!
Starting point: You spend more than you earn
This is where we all start out. At first, it’s unavoidable: as children, we begin life by relying on our parents’ income to survive.
However, many continue this as adults by taking out debt to support their lifestyle, with their repayments ending up being more than their income.
This is a spiral that can quickly get out of control and you should do every little thing that you can to escape it.
Level 1: You spend what you earn
This is when you are meeting your financial obligations. You are no longer taking on debt or relying on others to stay afloat. It is also when you may be able to start saving, even if it is just a tiny amount.
You have to start somewhere and this is absolutely a great place to do it. But you don’t want to hang around here for too long.
Level 2: You spend less than you earn
You have reached this stage when you have paid off all of your high-interest debts such as credit cards, car loans, personal loans etc. and are beginning to accumulate savings.
You may continue to have certain other debts, such as student loans or a mortgage. But you should be able to easily make these repayments and still have an emergency stash for any nasty financial surprises.
This is where you are setting up the good habits that will last you the rest of your life. If you’ve reached this point, the exact same lessons that you are applying now are the same as those that will allow you to reach financial freedom.
Level 3: You earn enough and/or save enough to live how you want
You’ve paid off all your debt (ideally. Some people reach this point while choosing to still have a mortgage; if so, you will have enough saved/invested to be able to continue easily paying it off).
Your savings/investments have reached a point where, if you were fired or wanted to resign, you wouldn’t be left starving to death in the street – far from it, in fact. JL Collins calls it “F-you money”. While you couldn’t live forever off your investments, you’re at a point where even taking a few years off from working wouldn’t be a problem for you.
This is where things really start to get interesting. Suddenly, by not having to allocate funds to paying off your debts, you’re able to put all of that money into your investments. Your profit margin can sky rocket and, consequently, you’ll accelerate your journey to financial freedom.
Remember: a simple increase of your profit margin from 5% to 10% halves the amount of time needed to reach your financial goal.
Once you’re at this stage, you should easily be able to work at increasing this again and again, even up to 50%.
(This is where I am at the moment. Currently in my early 30s, I save 70% of my income and would easily be able to stop working for a number of years without any issues. It’s such a great feeling to not have to worry about money, but I’m looking forward to continuing up to the next few levels to really open up my options.)
Level 4: Your investments cover your basic needs
You aren’t able to do absolutely whatever you want at this stage, but you can certainly afford to live without working another day of your life if you wanted to. Basic food and shelter are covered, as are essentials such as simple clothes and health insurance.
This is where you really start to have a taste of financial freedom. Sure, you have to be careful that your lifestyle doesn’t exceed what you have – but this is actually something to be mindful of at all times, even when your investments have grown.
Nevertheless, you’re at a point where you start to have options. You can choose to work or not. Consider starting a side business. Spend your time engaging in a (financially conservative) hobby – which you can even make money from!
Essentially, the end goal of financial freedom is in sight!
Level 5: Your investments let you live your life!
This is it. The end goal. True financial independence!
The passive income earned from your investments lets you continue living your current life, even if you don’t actively earn another cent. You’re comfortable and can do (almost) whatever you want.
Travel. Become the entrepreneur you’ve always wanted to be. Go fishing for the rest of your days.
Continue living your existing lifestyle and you’ll be able to afford it forever!
Secret bonus level!
You may decide to continue working after reaching the previous step. Or you may take the opportunity of being financially free to build a new source of income, such as a business. However you choose to do it, you have continued to earn money and grow your investments even when you have passed the point of financial independence.
Essentially, this is when you are financially free but can truly do whatever you want.
Not only will you travel, but you can take that round the world cruise which you’ve been dreaming about.
Not only will you become an entrepreneur, but you can invest in your business to a point where you are seeing real growth and financial success.
You can go fishing, but in any corner of the globe that you wish to drop a line.
You can also take the opportunity to give to others who may be in need.
This level of wealth is absolutely not necessary to be financially free, nor is it necessary to live a great life doing what you want.
But it can certainly be damn nice. Better yet, it can enrich your life in ways beyond financial rewards. Having the ability to use your means to help those who need it can bring wealth that no bank manager can calculate.
But how do I get there?
Well, kind of.
Make your money work for you
If that’s not particularly motivating and you’re inching towards closing this page because there’s no way in hell that you can do that, perhaps think of it this way:
More savings –> More freedom –> More options
That is, don’t think of it as forcing yourself to save. Think of it as doubling your efforts to be financially free – and thus halving the time it takes for you to get there.
The harder you work now at working towards saving 10% of your income, the less you’ll have to work in future.
The more effort you put in to increasing your earnings so that you can pay off your debts and maximise your investments, the more time you’ll have in future to do what you want.
There’s not some special, rich person trick.
Getting from one level to the next involves exactly the same process that you followed to reach the previous one.
And as your thinking starts to change to allow you make it to each rung of the ladder, what was previously a conscious effort to spend less or earn more will become a habit.
Why buy lunch everyday when I could bring it from home for one quarter of the price? Do I need to take a taxi home when the bus is right there? Should I pay for a gym membership when I have a phone that can do the same thing?
Its habits like these that will, in turn, allow you to get to the next rung. And which will then accelerate the time needed to pull yourself up even further.
And before you know it, you’re inviting me for a glass of champagne on your beach vacation.
(Sorry for inviting myself.) (I’m not that sorry.)
(If you would like more information on the concepts in this article, consider checking out JD Roth’s post here. He’s the one who I first saw set this out as a multi-step process – to which I’ve now added some of my own tweaks.)
So which level are you currently on – and where do you think you can be in five years?