Financial independence is generally used to describe the state of having sufficient personal wealth to live, without having to work actively for basic necessities. For financially independent people, their assets generate income that is greater than their expenses.
There is no quick way to become rich unless you win the lottery – and even then, the odds are against you on that happening. Unless you believe in fairies that will rescue you from your financial problems, you will have to do it on your own.
The good news!
If you live in London, Ontario, you have a very strong chance of reaching financial independence and living the life you’ve always dreamed of. There are many ways to get there and I would like to propose the stages to help in becoming financially free.
In this day and age when good jobs are less available and full-time work is becoming harder to come by, it is time for young people to think about becoming more financially self-reliant. Automation and government cutbacks to services is changing the financial security that this generation’s parents and grandparents took for granted.
Stage 0: Being financially dependent on others
Most of us start out being dependent on others to provide our daily needs like clothing, food and shelter. Young adults start to think about becoming independent and moving out on their own. Some can handle this transition better than others.
For those who are able to get out on their own, reality kicks in and they start to realize how challenging it can be to find work, keep it and provide for their essential needs. Some, unfortunately have to go into debt in the process.
Stage 1: Being financially self-reliant
In this stage you learn to support yourself. You are able to live on the income you generate to support your lifestyle – and you stay up to date on your bills.
Creating an income is pretty new to most people who leave the nest for the first time. Perhaps you have to work at a couple of jobs at first to cover the bills until one of those jobs lets you make enough to support yourself. In the process of securing that better job, you may have to take on some debt.
Hopefully, your debt hasn’t grown too much and you are able to get employment that is greater than your lifestyle needs so you can pay off your debt and enjoy a little extra income for fun.
For those who were reliant on their parents for many years, this is a glorious time in their lives. Now for the first time they are able to control their own destiny and realize newfound freedoms they never experienced when living by their parents’ rules.
Stage 2: Becoming financially stable
At this stage you are staying up to date with your bills and you have a nice emergency/liquidity fund in place – one that could pay for emergency purchases like unexpected car repairs in case of job loss or other unforeseen circumstances. Money in an emergency/liquidity fund should not be used for common needs like vacations and small purchases. Saving for vacations and car purchases should happen in a separate savings or investment account.
Now the stress level starts to drop and there is a glimpse of financial freedom. With a three-to-six-month emergency/liquidity fund established (or more for some who need it), unexpected opportunities start to appear. You may start planning to buy a home or start an investment account. You may also like to add insurance which has a cash-growth component to provide more financial stability for you and your family.
Stage 3: Dashing the debt load
At this point, you learn to hate bad debt like car loans and credit card debt (debt that is connected with living beyond your means and depreciating assets). You now make a plan to be free of this type of debt to gain the ability to grow your investments and build your own credit source.
You should target debt with the highest interest rate first, then work on eliminating the debt with a lower interest rate – like student debt, perhaps. Once you have eliminated a great portion of this debt, you can redirect your debt payments to add to appreciating your investments or paying down your mortgage.
Some people try to eliminate all of their debt before they start investing. Although noble, this can be a frustrating time for if they do not have a sufficient emergency/liquidity fund in place and they find themselves regressing and using credit cards in a financial crisis. I recommend building an emergency/liquidity fund at the same time you target paying down your bad debt. This gives you the ability to use some of the growth in your investments to help knock down your debt.
Stage 4: Becoming financially secure
Your main goal is to free yourself from your need to earn a paycheque. You are trying to create a passive income stream to pay for your lifestyle. At this stage, you have controlled the amount of bad debt you hold and you are actively building your investments. Your goal is to build your investments and pay off your mortgage to the point that the income generated pays for your living expenses.
Once you have built enough income (other than government and company pension income) to pay for your housing expenses, taxes and daily living expenses, you have achieved financial security. Congratulations! Not many people reach this point and it is a good time to have a celebration.
Stage 5: Becoming financially independent
At this stage in your journey to financial independence, you have accumulated enough assets to generate the income stream necessary to pay for your lifestyle and more. This is when you can choose between continuing to work at your job or switch to another career – or simply stop to manage your own investments.
Don’t forget to continue looking for and taking advantage of investment opportunities. If your passive income stream exceeds your needs, why not take some of that extra income and invest it? It is a good practice to keep saving so that you will have a better chance of not running out of money and potentially accumulating wealth.
Stage 6: Realizing financial freedom
Once you achieve financial independence, you have come into a new realm of living that is more stress-free. It is like being a child with very few cares in the world!
You may come to the conclusion that you would like to increase your lifestyle and be able to enjoy more – like taking bigger trips, helping out with charities that you admire or starting a small business.
Having money gives you the opportunity to hire people to do those mundane tasks like cleaning your home and grocery shopping. You may even want to hire a chef or a driver.
At this point, you may want to redefine your goals in life – and make sure they line up with the amount of income you are generating so you don’t drift back into debt.
Stage 7: Enjoying financial excess
Yes – there is a stage beyond financial independence and it is achieved by very few individuals. At this level, you have more than enough passive income to live on and fund your re-established new lifestyle.
What do you do now? Well, you could mentor other people to do the same or start building a charitable foundation to give to charities you now support. Life insurance can help with this stage in leaving a legacy to family members and charities of your choice. Once you have your foundation established, others who believe in the same causes you believe in can contribute to your foundation.
Each one of these stages should have the proper level of insurance in place – appropriate to your budget – and use a good financial security advisor, accountant and – if necessary – a lawyer to help you manage your investments and other assets properly.
If you have worked hard to build your financial independence or plan to for years to come, it’s incredibly important that you secure what you have built with insurance.