4 Stages of Financial Independence

At it’s most basic, retirement means one thing:  passive income.  It doesn’t matter if you’re a millionaire or even more, if you don’t have money rolling in each month, passively, you still gotta go to work.  Getting clear about exactly what it takes to retire means you’re much more likely to make financial decisions that get you there.  There are 4 stages I think make sense to use a framework when thinking about passive income.

Stage 0.5 – PARTIAL RETIREMENT:  Imagine your monthly expenses are 5k a month.  For many people starting at 0 that might seem like an unattainable number – so they imagine retirement to be binary – either retired or not retired – and as something in the far off future they hope to achieve “someday.”  But could you get to 2.5k a month?  Because then you could work half as many hours each week and still be covering expenses!  How would it feel to work 20 hours a week instead of 40?  Pretty damn awesome.  Is it irresponsible to not work 40 hours?  Hell no.  If you’re making the same amount of money you were before and your investments are getting you half way there – now you have choices.  Play with all that extra time.  Work and use the savings for other things – like Stage 1.

Stage 1:  SURVIVAL:  Survival means you are at 5k a month in passive income and 5k a month in expenses.  You can survive fully on your passive income.  This stage is really liberating.  You can wake up every day for a month or a year, and do effectively nothing.  You can work 40 hours a week, 70 hours a week, or zero.  Want a vacation?  for 3 months overseas?  Done.  It’s a game changer.  However, you’ll realize you have no margin for error – which in real life, always happens.

STAGE 2:  SAFETY:  I like to define safety as 2x your monthly expenses.  This would mean that half of you income could disappear and you are still good.  That’s a large buffer and truth is anything above 1x expenses is safety money.  At 2x you have reached a distinct safety level.  Lots can go wrong and your life is still good.  Market changes, rents go down, unexpected medical expenses, want to help a friend in need, whatever – you can absorb a very, very high degree of unexpectedness.  You can even afford to splurge here and there and still feel very safe.  This stage sounds amazing because it is.  It’s not just retirement, it’s a whole next level of peace and safety.  You’re not on the edge of retirement – you have such a buffer that when people worry about changing economic conditions you already planned for it.  Hard to imagine financially anything better.

STAGE 3:  LUXURY:  Passive income is 3x your monthly expenses.  At this stage monthly expenses (survival) are covered, a substantial buffer of safety exists  Chances are quite high if you’ve achieved this level you’re frugal with your spending and a good investor with your money.  When you keep continuing those traits they eventually get you to “luxury.”  Where each month even if you went crazy playing / traveling / spending, you’d still end the month with more than you started.  This is a stage where you can start asking, what’s something I really want that is a luxury?  Not for others, but for you.  Love to cook?  Nicest kitchen you can think of.  Love cars?  Which car?  Want to pay for family trips?  Really this stage is where money starts to border on irrelevant for most expenses.  You really start to feel the diminishing utility of extra money at this stage.  1k more when you’re in partial retirement is HUGE.  At luxury, it’s nice.  It buys nicer plane tickets, an extra trip.  Mostly what it buys is that it substantially removes the cost of something from the analysis.  It’s more a question of do you really want it.  In fact, when you can have anything, then the question is what do you really want (much less what does it cost).  What I’ve found with people who reach this level is the opposite of what poor people expect.  Instead of buying everything in sight, they actually start to thin a lot of the stuff they already have.  A realization that you can have nearly anything gets rid of the “scarcity” of not being able to have something.  Quickly stuff just feels like clutter.  Instead you want minimal things – but what you have is high quality.  Instead of stuff, you buy time.  You buy experiences – travel, time with loved ones, freedom from doing things you don’t enjoy, convenience (skipping airport lines, pre-cooked healthy food, etc).  At this stage, life at this stage is the least about money.

Most people think of retirement in a binary way – retired or not retired.  I think it’s much more helpful to see and experience it as a continuum from partial retirement to survival to safety to luxury.

I would add that while I think these stages are pretty applicable for everyone, the multiplier you use could vary greatly from what I used.  If you’re a school teacher in retirement, your income is VERY predictable so 2x income may be greatly excessive for safety.  Maybe 25% would qualfy.  Luxury might be 50%.  The greater your income could vary, the wider the margin of safety you might want is.