Levels of Financial Independence – even during a global crisis
Today we’re going to talk about the levels of financial independence.
It’s been a while since I talked about financial stuff on here…
But back in February, I wrote an article I called the Ultimate Guide to FIRE, about the movement to achieve financial independence and retire early.
Of course, as we all know, a few weeks later most of the planet went into lockdown because of this Covid thing, and since then, many people have claimed that the FIRE movement is dead.
Is it? Or is it still possible to achieve financial independence, even in the midst of a crisis like this one?
Well, I think financial independence is more important than ever.
And I’ll tell you why.
The Government Isn’t Going to Save You
Here in Barcelona, I woke up last week to the news that the regional government was thinking about closing the bars and restaurants “for two weeks”.
“Surely”, I thought, “they wouldn’t do something so utterly moronic… AGAIN!”
Always the optimist… That’ll be your downfall, Mr Chorizo.
By lunchtime they’d made the official announcement: bars and restaurants will be closed, except for takeout, all over Catalonia.
Now, maybe your local (or national) government isn’t mostly composed of toxic blobs of sewage stuffed into dark suits like mine is…
But I think I know enough about current events to say that your government, wherever you are, probably isn’t going to save you from getting the coronavirus – and it might just ruin your life in the meantime.
So in my opinion, financial independence is more important than ever.
Now if you think what I mean by “financial independence” is that you have to buy a Lamborghini and a castle in the South of France, and to live like some trust-fund douche, you’ve got me all wrong.
What I mean by financial independence is that you need to live below your means, and have an emergency fund and multiple income streams which will keep working for you, even if the shit hits the fan.
You need to be okay losing your job, if you have one, because you’ve already got other things bringing in some cash.
You need to diversify your life.
Because anything could happen…
It’s been a strange year, this 2020.
As we’ve seen all over Spain, today’s bustling tourist area is tomorrow’s ghost town.
If you’ve got a brick-and-mortar business in one of those areas, this year just isn’t going well for you.
And of course, it’s not your fault. You thought you were pretty bright, selling ice-cream in summer to a hot, carb-addicted audience of millions.
And you were bright. That’s the sad thing.
Because this perfect storm of pandemic plus government restrictions on everything doesn’t care how good your business model was last year.
In 2020, all bets are off.
Once-in-a-century events happen, and of course, almost nobody is prepared for them. After all, they only happen once in a century.
So: multiple income streams for the win. Or at least multiple (marketable) skills.
In other words, start that side hustle today. Because if the government makes your job illegal tomorrow, you’d better have some sort of backup plan.
(Side note for those who might be living in a fantasy world where socialism will come to their rescue: Spain has a socialist government. And the free healthcare isn’t bad. But besides that, your fantasies of what socialism is like are probably unrealistic – you can easily live in a rent trap and earn minimum wage while barely being able to feed your family, even under socialism. Millions do. Don’t @ me.)
(Another side note for those who would suggest that European countries just “aren’t doing socialism right”: do us all a favor and move to Venezuela, then. I hear they’re doing great down there.)
Anyway, today we’re going to talk about…
The levels of financial independence
I had a coworker, years ago, who was a guy in his 40s. I think he was a Texan or something. He was a douche.
One day, Mr Douche from Texas (or something) made a passing remark in the break room: “Payday is on Monday”, he said, “and I can only afford to eat rice and beans until then.”
Let’s call that level 1 of financial independence.
Level 0 would be you’re dependent on welfare or charity (or your mom) to pay your bills. You’ve got nothing but someone else’s goodwill. You can read Ed Latimore’s blog for more about moving out of Level 0.
Level 1, where the douche was, is a whole ‘nother ballgame: you’ve you’ve got a job you may or may not like, and a boss you may or may not hate, but it’s still barely enough to make ends meet.
‘Cause here’s the fun thing about bosses: if they want, they can fire you. And guess what? If you don’t have those multiple streams when it happens, your income just went to zero.
Case in point… a lot of people Morena knows are having to go back to the office these days, after months of working at home. And they complain about it. “But I don’t wanna go back to the office! There might be a coronavirus on the toilet seat… and besides, I like working from home. Only thing is, my jerk-ass boss is telling me I have to go back.”
Morena reports these conversations to me, and my response is always the same. “So your friend Lulu doesn’t wanna go back to work, huh? Well, what do her other income streams look like?”
“She doesn’t have any other income streams.”
“Then I guess she’s gonna do what her boss tells her to, and not what she wanna.”
In other words, having a boss is a system with a single point of failure. Whatever marketable skill you have, if you have one boss who can fire you tomorrow, you’re not financially free – and not anywhere near it.
So level 1 is a huge step up from total dependence – but wait till you see what’s coming…
Level 2 of financial independence would be living slightly below your means and having an emergency fund so you can meet some unexpected expense. If your car breaks down, are you able to get it fixed? Or are you out trying to pawn your hairdryer to pay the mechanic? Are you eating rice and beans until payday, or do you have enough money you can afford steak, even at the end of the month?
Level 3 includes the emergency fund, but with the addition that you don’t have any debt or credit card bills. (Maybe you’ve got a mortgage – ONE mortgage – on your primary residence. We can argue about whether real estate is a great investment another day.)
I’m not sure if I should swap those last two levels or not. Is it more important to have the emergency fund first? Or to get out of debt?
Honestly, I think the most important thing is the emergency fund. But let’s be clear: you should be paying down your debt at the same time you’re saving. Paying 19% interest to your credit card company is slowly sucking the life out of you, whether you’re consciously aware of it or not.
Level 4 of financial independence: You’ve got no debt, you’ve got an emergency fund… And you’re got 6 months of your monthly expenses saved up. I call it F.U. money, and it helped me a lot back when I was in the process of quitting my (several) jobs.
Basically, having 6 months of living expenses saved up gives you the freedom (or maybe you’d prefer to say the power) to tell your boss to “Eff You” at any moment… because you’ll be fine either way.
It’s quite a mental shift, if you’ve never had that much in the bank before. You’ll feel happier, and mentally lighter. Level 4 is great!
And honestly, if you want to stop there, that’s fine…
Because once again, I’M NOT SAYING YOU HAVE TO GET RICH!
For real: go ahead and don’t get rich if that’s what you’re comfortable with.
I’m talking more about being antifragile: when the shit hits the fan, you’re not out the next week picking strawberries or selling your butthole on a streetcorner. (Unless those are things you enjoy doing, in which case I’m not gonna judge. Lots of people love gardening and anal play.)
So now let’s talk about…
Higher levels of financial independence
There are, of course, higher levels to this.
Level 5 is where you have at least a couple (or several) years of living expenses saved up. Keep in mind, most people don’t work this way at all: as soon as they get some savings, or max out their yearly contribution to their retirement account, they go around looking for ways to make their lifestyle more expensive.
They’re not making it a point to always live well below their means.
And there’s nothing wrong with that. But it’ll keep them from growing that nest egg and reaching…
Level 6 of financial independence: the holy grail of the FIRE community
Here’s the big one.
At level 6, you’re able to take advantage of the 4% rule I explain in my previous article. You’ve got 25 years of your living expenses invested in those Index Funds, so you’re able to withdraw 4% a year or less. This should last, under any economic conditions, until you’re dead.
In other words, work is completely optional at this point. You can work, and keep adding to that nest egg. Or you can quit.
Usual caveats apply: this is based on the US economy, and returns for the S&P 500. In your country things may be different, but you can probably figure something out.
And you can, of course, do this in other ways. Royalties off of creative work can pay you a steady income. Or you could have so much invested that you only live off of the interest and dividends. But the 4% rule seems to be the gold standard.
After that, all we’ve got left is…
Level 7: Abundance / Generational Wealth – At level 7, you’ve got way too much money to ever spend in your lifetime. Some people, at this point, dedicate themselves to philanthropy or some such – think Bill Gates and his foundation.
You’ve also got enough to leave a massive inheritance to your kids.
If you do reach this point, congrats. Your family might not have to work for generations.
But don’t worry: your heirs will eventually find some way to waste the money. Even the Rockefellers are on a slow downhill these days.
My final thoughts about the levels of financial independence
I keep talking about a side hustle because, of course, it’s better to have multiple streams of income.
Single point of failure = bad.
But technically, you can do most of this with one income. You can even do it with your job if you want.
(You won’t get to Generational Wealth working at your day job, but you probably don’t need or want that much money anyway.)
The fact is, your job is just another income stream – although probably more time-consuming than others.
Optimize your lifestyle to have maximal fun with minimal cost, and there’s no stopping you.
I’m also harping upon “minimal cost” because without that, none of the rest is possible. It doesn’t matter how much you earn, if you’re spending it all every month. Nobody cares about your stuff anyway.
And as my dogg Morgan Housel says in his new book, “Spending money to show people how much money you have is the fastest way to have less money.”
So… Like I said, you don’t have to be Rockefeller rich to make good use of this information. There’s a whole world of difference between level 1 and level 4 of the financial independence game.
Move up a couple of levels, and your life will be a LOT better.
Have fun, kids.
P.S. It’s a beautiful weekend here in Barcelona, and like I said, everything’s closed. I’m outraged like you wouldn’t believe. But hey, the US election is in about two weeks, and I’m sure the general level of outrage is only going to go up from here to the end of the year. So let’s just live our lives, for now…