What does financial independence or financial freedom mean to you? What does it conjure up in your mind when you hear those terms? Does it feel like an unrealistic notion? Do they feel unattainable? Unachievable? A concept so far in the future that it’s not worth worrying about. Or it’s too scary and too complex to contemplate, so you just put it off and hope that it will just sort itself out if you keep working hard enough?
And what exactly is financial independence or financial freedom anyway? How do you get there? What do you do in the meantime? And how can I enjoy life now and invest in my future in a way that doesn’t restrict my lifestyle and enjoyment of life?
I hear about financial freedom from people who’ve achieved this holy grail, and they drone on and on about how they are spending practically nothing so they can retire at a much younger age, like 30. Conversely, you then hear the stories of those who may have already achieved financial freedom and are bragging about how frugal they were, so they could retire well before the typical retirement age. This is not what I what to hear. Sell all your stuff, except for a tent, and move to the woods so you’ll never have to pay rent or utilities again. No thank you!
Realistically, most of us will not want to do the things required to retire at 30, 40, or 50. In fact, many hard-working Aussies are not saving or investing enough to maintain their current standard of living during their golden years, even if they retired at the age of 70.
Financial independence vs financial freedom
Unfortunately, financial independence and financial freedom are terms that are bandied around all the time. They often feel like some far off mystical and unattainable place, so we just give up or keep putting it off for another day. Or, we’re often so bogged down by day-to-day living, that reaching financial freedom seems like a pipe dream.
But what do these terms really mean? Are they the same or different? and what does it matter? And how do you know where you are at, so you know what to do next to achieve your definition of freedom?
In the past, I’ve always said that financial freedom is about being able to do what I want, where I want, with who I want, and when I want. I believe that freedom is more about time than it is about money, and that true fulfillment only comes when you can give freely to others without expecting anything in return. I believe that you can only enjoy the fulfillment of giving if you have freedom of time on your hands and that you can only have free time on your hands if your income needs are being met without relying on you to generate them. In other words, getting your money to work for you rather than the other way around.
This triggers another key question: If your work income stopped today, how long could you afford to maintain your current lifestyle? For most it is days and weeks, for some it is months, and for a very, very few it’s years. What about you? This is a good measure of your true freedom.
Now I used to believe that financial freedom meant just one thing: having enough money that you never had to work again. But over the years, I’ve learnt that financial independence exists on a continuum. It’s not “all or nothing”, but an ever-increasing range of options. It’s a journey and a process where each stage of financial freedom allows you greater autonomy, greater self-expression, and greater fulfillment and lifestyle satisfaction.
Financial independence and freedom is a journey, not a destination, so how do you climb the mountain to financial freedom while enjoying the journey comfortably in the meantime?
The stages of financial independence
Let’s start by spelling out the various stages and phases involved, so you can gauge where you are at and where you want to get to. Now if you google search the words ‘financial independence’, ‘financial freedom’, ‘wealth’ etc, you see that there are a multitude of different definitions, stages, phases, and levels (I found anywhere from 3 through to 11 different stages). Now I want to keep it relatively simple, so I’ve settled on 7 stages, and of course in true Bushmeister style, I’ve framed them around an acronym that I call MODEERF.
Stage 1: Money Misery
The first financial level is the M for Money Misery stage – the stage when you’re financially dependent on money or credit from others to sustain your lifestyle. If you’re financially dependent, then you are suffering negative worth, meaning the value of your assets or what you own is less than what you owe others, and/or your income is less than your expenses.
You’re in this stage if you rely on financial support from your parents. You’re in this stage if you spend more than you earn. You’re in this stage if your debt repayments exceed your income.
If you’re financially dependent, you’re forced to borrow consistently from banks, credit cards, personal or car loans, use interest-free store cards, or rely on friends and family for the lifestyle that you’re living. You’re living beyond your means.
Interestingly, money misery is not restricted to low-income earners. To the contrary, you often see people in this category driving the newest cars, with the flashiest clothes and all of the latest gadgets, always out partying and living the high life, eating at the most expensive restaurants and going on expensive overseas holidays…their Insta feed looks awesome!
But if you take a peek under the bonnet at their financial worth, you see a very different story. I’ve seen doctors, lawyers, real estate agents (you name it!) in this scary position. They have all the gear but no idea, and they’re literally drowning in debt and living way beyond their means. More money is spent than what is earned. They live well today, but tomorrow is getting uglier by the day. This is an increasingly stressful ride. Serious budgeting and money control are required to turn this around.
Stage 2: Out of the red
After this, the next level is the ‘surviving’ stage – O in MODEERF is for Out of the Red. You earn enough income to pay your bills, but you’re using all of it to cover your debt and expenses. Here the ‘O’ is more a zero. You are just balancing the books. You’re just keeping your head above water. You’re living paycheck to paycheck – it’s what many refer to as the solvency stage. You’re able to meet your current financial commitments and you are no longer accumulating debt. You are effectively in survival mode.
When you are earning a small profit, you’ve achieved solvency. You’re out of the red and into the black. Some people reach this stage in their teens. Sadly, some never reach it.
Stage 3: Dependable phase
Paying off your debts
The third level of D in MODEERF is when you reach the Dependable phase. You’re now in the stable stage where you’re not only meeting your financial commitments consistently, but you’re paying down and paying off your bad debts (like credit cards, store cards, personal and car loans). Most importantly, you’re starting to save. You’ve created the often-illusive gap between your salary and your spending, and your savings are increasing and starting to accumulate.
But you’re probably not debt free yet, and that’s okay. You may still have some significant debts like paying off your student loan debt or paying down a mortgage, which you’re chipping away at.
Building your emergency fund
You’re also creating a rainy-day saving fund that will cover emergencies or unforeseen expenses. The goal here is to buy yourself some time so that if you lose your work income or a costly unforeseen emergency arrives, like surgery or an extended illness, you can survive comfortably for a length of time (ideally for a minimum of 3 months and preferably 6-12 months).
The rule of thumb here is to save or create an emergency fund that is somewhere between a half and 1x your current income after tax. So, if you’re earning $80k a year net after-tax, then you have cash savings or an equity war chest of between $40k to $80k that you can fall back on to live comfortably for 6-12 months.
Creating your rainy-day emergency fund is actually more important than paying off all your debts. It can be via cash savings, or by accessing available equity in your home via a separate low-cost interest-only loan that costs you nothing if you don’t use it and is a fraction of the cost of a credit card or overdraft. Without emergency funds to fall back on, you may find yourself paying off your debts with all your income. Then, if you have one unexpected hospital emergency, you’re forced to turn to your credit card or other family members to help and you’re back to square one in Money Misery.
Stage 4: Empowered expansion
At this stage, you’ve paid off all of your high-interest debt with the exception of your home loan. No more credit cards, interest-free cards, car loans, or personal loans.
On top of your emergency rainy-day fund, you’re stretching your savings or equity war chest to 1-3 times your income to give you some ‘stuff you’ money, which you can fall back on if your work or job gets too hard and you need some time out or a new start.
Financial freedom is all about making work an option. Saving enough money to quit your job forever is a huge undertaking but accumulating enough money to be able to take some time away from working is a big jump in that direction. This doesn’t mean you have to quit your job, but it sure is a good feeling to know you can. It also gives you the option of taking a sabbatical or an extended vacation to spend a month, or two, in a foreign country every year.
The freedom of time
Freedom of time is also now becoming an option in the empowered expansion stage. What many of you desire is more flexibility with your schedules. In this way, freedom of time and financial independence go hand-in-hand. Together, they are about leaving the rat race to follow your passion, or spend more time with family and friends, and not going broke while doing it. It could come in the form of more paid time off, flex-time or perhaps working remotely on a regular basis. Not having to take a day off from work just so you can visit the dentist or take your kids to the doctor could be a huge benefit to you.
Embracing new opportunities
This level of rainy-day reserves or ‘stuff you’ money is large enough that it’s now affecting your confidence in how you see the world. Things that used to look risky are now looking like great opportunities, and you have now given yourself the option to say NO and know that you’ll be fine.
Don’t underestimate the peace of mind this gives you knowing that you’re not reliant on your current job – if you leave your work, whether you decide to leave or someone decides for you, you’re going to be okay and you can afford to be choosy in where and when you decide to work next.
You’ve now reached what many refer to as the security stage, where you’ve built up a comfortable rainy-day reserve, and it’s time to start investing. You’re starting to make your money work for you to create more money.
You’ve had your super moment when you realise that only putting money into super and paying off your home loan is going to give you just two choices:
- To see your lifestyle, fall of the cliff when you try and stop work and survive in penny-pinching poverty, or
- Keep working till you drop – and sadly this is the case for over 73% of Aussies over the age of 65 who are retiring on an average of just $15,300 a year.
Investing your savings
You’re now investing savings in a mix of rental properties, shares, and index funds to build a diversified portfolio that will allow time, tenants, the tax office, and capital growth to replace your work income with passive investment income over the long term. During this stage, you will reach two important financial milestones: the Coast FI level and the Half FI level (where FI stands for financial independence).
Coast FI level
The coast level means that you’ve saved and invested enough that your nest egg will continue to grow to meet your ideal lifestyle income when you want to stop work, without having to add any additional savings.
At Coast FI level, you have saved and invested to a level where your nest egg is between 3-7 times your ideal lifestyle income. Your required income multiplier, or Freedom Number, is determined by how long before you want to be able to stop work.
As an example, if you’re looking to stop work and replace your income when you’re 65, then your FI freedom multiplier is approximately 3 if you are 25 years old, and 7 if you’re 40. So if your ideal ongoing lifestyle income is $120k a year, then your FI Freedom Number, based on the 3-7 multiplier, is an investment nest egg level now of $360k to $840k. This is determined by adding up the value of your super, investment properties, shares, and any other income-producing investments.
Note that your home is excluded from your nest egg. This is because your home is a liability rather than an asset, as it doesn’t actually put money in your pocket. Instead, it actually takes money out of your pocket, and if you sell it, you’ve still got to live somewhere.
Half FI level
During this empowered expansion stage, you’ll also reach the Half Freedom level, where you have enough investment income to cover roughly half of your expenses.
If you’re in a relationship, you then have the option that one of you can stop work to pursue other interests, or one or both of you can reduce the amount of time you are working.
This Half Freedom Number will generally be 10-15 times your combined income. So, if your combined income is $120k, then your Half Freedom Number will be an investment nest egg worth of $1.2M to $1.8M, depending on which partner earns more and who will give up work.
From surviving to thriving
Your lifestyle choices and options are now significantly increasing. We now start moving into the final three stages, where you move from surviving to thriving. This is a time when money is no longer a safety net, but a tool to help you build the life you envision for yourself and your family. As Tony Robbins says, you can’t earn your way to wealth, you have to invest.
Please note: Each of these following stages assumes you have no bad debt, only tax-deductible investment debt. In other words, you have enough cash on hand to instantly repay your debt, like having offset savings equalling the outstanding amount on your home loan.
Stage 5: Elevated enjoyment
The fifth level is the second E in MODEERF, which is for the eclipse level of Elevated Enjoyment. You have now reached the level of financial security where your passive income from your investments (like rent from property, dividends from shares, or income from your business) covers your basic lifestyle survival costs.
You will never have to worry about the basics again. The income from your investments covers all of your base survival costs. So, based on how much you have saved and invested, you could live a lean existence for the rest of your life. Even if you never worked another day, you have enough to afford simple housing, basic food, essential clothing, and more. This doesn’t include cars, eating out, phone, gym membership costs, etc.
This stage is often referred to as lean financial independence, where your investment nest egg is valued at 17-20 times your lifestyle income. So, if $120k is your lifestyle income, then your nest egg value needs to be between $2M and $2.4M
This level of financial security gives you the confidence in knowing that, even if you were to lose your job today and you never worked again, you could still cover all your essential expenses.
Stage 6: Replacement reward
The sixth R level in MODEERF is the Replacement Reward stage. You have now reached true financial independence, where the passive income from your investments has totally replaced your active work income to fund your current lifestyle. In other words, you no longer need to trade your time for money.
This level of financial independence is the ultimate goal for most people. At this stage, your investment income is sufficient to fund your current standard of living for the rest of your life. You can afford the basics, but you can afford some comforts too. You have enough to enjoy life.
The freedom number that generally gives you this is 25 times your ideal lifestyle income. So again, if we use $120k, this means your investment nest egg is now worth $3M. This is referred to as the 25x rule, or the 4% rule, which assumes that you can live comfortably on 4% of the income from your investment nest egg value.
Stage 7: Financial freedom
The final seventh level of MODEERF is the Fulfilment Financial Freedom stage. This is the level when your investment income funds your ideal lifestyle, so you can enjoy the fulfillment of giving your time and money freely to others without ever expecting anything in return.
In this final stage of financial freedom, you not only have enough, you have “enough — and then some”. Your passive income from all sources will not only fund your lifestyle indefinitely but grant you the freedom to do whatever you want. You can share your wealth with others. You can indulge in luxury or explore the world.
At this stage, the power of compounding returns has created a perpetual money-making machine that will continue to generate a financial legacy that will outlive you and protect your family for the next generation – what many like to refer to as the abundance stage.
So there you have it – the 7 MODEERF stages of financial independence. And if you spell MODEERF backwards, it gives you FREEDOM.
Sadly, some of us don’t move up through all of the stages, and most don’t reach fulfillment freedom. And it’s not a one-way street – we can move down a level as well as up. It can be a bit like Snakes and Ladders – with divorce and ill health often being the snakes, and investment or inheritance often being the ladder. And you might deliberately make choices that move you back a level (like moving to a new house and increasing your mortgage).
So, it’s important to realise that financial independence is actually a journey, not a destination. This then begs the question, “where exactly am I on this journey?”. It can take a decade or two to reach financial independence, so it’s important to occasionally zoom out and know where you are so you can keep motivated and stay on course. Seeing the big picture also allows you to confidently pause your journey when ‘life happens’ without feeling like you’re moving backwards or giving up.
And everyone’s different. But while almost everyone can adapt to their stuff, having control over your time through independence will always feel great when you have it and will always be a miserable burden when you don’t.
This 7-stage freedom framework also helps you to understand the financial impacts of the choices we make day to day. And here are some of the takeaways and rules of thumb that support this.
The financial rules of thumb
Firstly, money is a paradox. In our western capitalised society, where money is our life-giving oxygen, the less money you have, the more you have to focus on it and the more it controls you. And conversely, the more money you have, the less you need to worry about it.
Secondly, the more money you save and invest, the more freedom you have. There are also greater risks you can take, and you’ll reach your desired level of financial independence and freedom quicker.
Thirdly, the 4% rule or the 25x rule is a great rule of thumb for figuring out how much you need to reach your financial independence. Once you have saved 25x your annual expenses in investments – assuming average market returns over time – it will easily be enough to cover your expenses for the rest of your life in inflation-adjusted dollars. Note that it’s not based on income, it’s based on spending, so for each $100 per month you can cut from your budget, that’s approximately $30,000 less you need to save. Even just a 1% increase in savings will give you approximately two years more financial freedom.
And let’s not forget the impact of this lifestyle investment approach on your mindset. As your level of financial independence increases, you chip away at the ‘wall of worry’ and you’re able to make decisions based on what makes you happy, not on dollars.
So, where are you now and where do you want to get to? There is no one size fits all – the choice is totally yours, but it’s useful to think about where you are and where you want to end up.
Enjoying your life and living by design
The key question still remains – how do you enjoy life now while you’re on the journey to financial independence and financial freedom? Certainly not like an ultra-marathon runner doing it tough, where every step is a painful slog up a mountain covered in clouds and you can never actually see the peak. Instead, you want an enjoyable walk in the park.
So, how can you live well now while enjoying the peace of mind of knowing that your investments are replacing your work income gradually over time? Again, it’s all about time – how can you enjoy the time now, while taking the time now to invest in your future so that you use the time you have to get your free time back?
And how can you achieve financial independence without living on a diet of toast and 2-minute noodles while watching constant reruns of Seinfeld because you can’t afford to do anything else? What if there is a different way to look at it? What if there is a way to achieve freedom long term that also helps you with your lifestyle goals in the short to medium term?
It’s about creating choices now so that you can be living it now rather than waiting for an uncertain future. Because at the end of the day, it’s not about money – it’s about lifestyle choices. Unfortunately, many of us are still stuck in the old false construct of the dichotomy between working or retiring. We often don’t use the freedom and power our growing wealth enables us to create on the path to retirement.
What we need is an entirely new approach that enables us to use our progressively increasing financial position to live our best lives now, rather than putting things off to a future date that may never come.