Level 1: Clarity
The first step is taking stock of your financial situation — how much money you have, how much you owe, and what your goals are. You can’t get to where you want to go without knowing where you’re starting from.
Level 2: Self-Sufficiency
Next, you’ll want to be standing on your own two feet, financially speaking. This means earning enough to cover your expenses without any outside help, such as contributions from Mom and Dad.
At this level, you may be living paycheck-to-paycheck or taking on loans to make ends meet.
Level 3: Breathing room
People at Level 3 have money left over after living expenses that they can put toward goals such as building an emergency fund and investing for retirement.
Escaping Level 2 means giving yourself some financial leeway, which Sabatier notes doesn’t necessarily mean making a much bigger salary. Indeed, 31% of working Americans making over $100,000 live paycheck-to-paycheck, according to MagnifyMoney.
“Just because you make a lot of money doesn’t mean you’re actually saving that money,” Sabatier says. “Most people in this country live through debt.”
Level 4: Stability
Those who reach Level 4 havepaid down high interest rate debt such as credit card debt, and have stashed away six months’ worth of living expenses in an emergency fund. Building up emergency savings helps ensure that your finances won’t be thrown off track by unexpected circ*mstances.
At this level, you’re not worried if you lose your job or if you have to move to a different city.
When calculating how much you’d need to have saved, thinking about what your financial picture might look like understand exigent circ*mstances, rather than your regular, everyday expenses, financial experts say.
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“If you have a job loss, you’d make some changes. You’d probably cut your gym membership and get rid of your subscriptions, for instance,” Christine Benz, director of personal finance and retirement planning at Morningstar,“Think about the bare minimum you’d need to get by.”
Level 5: Flexibility
People at Level 5 have at least two years’ worth of living expenses saved. With those kinds of savings, you have the ability to think about your money terms of the time it can buy you: “You could take a year off from your job if you wanted to.”
You needn’t carry all of this money in cash. It could be a sum total from your savings and investment accounts. As long as you’re able to access that money somehow, if you need it, you have the flexibility to tether yourself, at least temporarily, from the workforce.
Level 6: Financial Independence
People who have achieved financial independence can live solely off the income generated from their investments.
You generally have one of two things. You either have a large pile of money in an investment portfolio that’s generating interest, or you have rental properties, and cashflow from the rent covers your living expenses, or a hybrid of the two.
To get here, you’ll have to invest a high percentage of your income, which couldrequire you to shift to a more modest lifestyleto drastically lower your cost of living. Pursuing this lifestyle requires a change in thinking away from the traditional paradigms of personal finance.
People are being taught to save 5%, 10%, 15% of their income, and maybe you’ll be able to retire when you’re 65. Thankfully, more young people are starting to understand that if they aggressively save and invest, they can work less and have more control over their future and their destiny.
Level 7: Abundant Wealth
Financially independent folks who live off their portfolio income rely on the 4% rule— a retirement rule of thumb that posits that an investor can safely withdraw 4%, adjusted for inflation, from a balanced portfolio of stocks and bonds each year, and be relatively certain that the money will continue to grow and won’t run out.
Although economists debate whether 4% is the optimal number (some more conservative observers think the right figure might be closer to 3.3%), the calculation behind it serves as the basis for establishing a FIRE number — the amount of money you’d need to retire and earn an annual income you could comfortably live on.
