7 Levels of Financial Freedom

The information below is taken from Rob Berger's excellent book Retire Before Mom and Dad.

Level 1: 1 month of expenses saved

Level 1 is an important start to your journey. It's here that you stop living paycheck to paycheck. You may only have a one-month cushion, but that's a big deal. It gives you breathing room for when -- not if -- the unexpected happens. Most Americans have not achieved Level 1 Financial Freedom.

Level 2: 3 months of expenses saved

At Level 2, you have what most financial gurus say is the minimum emergency fund you should have. You now have enough money in the bank to handle most emergencies. The money could even help survive a short-term job transition.

Level 3: 6 months of expenses saved

Level 3 is time for celebration. You've maxed out your emergency fund. You've got breathing room to handle emergencies and even several months of unemployment. It's at Level 3 that you've also gained some confidence. It takes commitment to save six months of expenses. It requires discipline and persistence. If you can reach Level 3, you can reach Level 7.

Level 4: 1 year of expenses saved

Level 4 is when things start to get interesting. Most of our Freedom Fund doesn’t come from putting aside money each month. That’s how it starts, of course, when you are trying to reach Level 1, 2, or even 3. Eventually, however, the money you save starts to earn a nice return. In fact, if done right, our investments will produce far more income than our jobs. That takes time, and it’s here at Level 4 that we start to get a glimpse of the power of compounding.

Level 5: 5 years of expenses saved

At Level 5, you’ve already exceeded the savings that most will achieve in a lifetime. Assuming $50,000 in annual expenses (the round number makes the math easier), for example, you’ve amassed $250,000 in savings and investments. At a 9.3% return (the average return of an 80/20 portfolio over the last 90 years), your Freedom Fund will generate almost $25,000 in returns over the next 12 months. In other words, your investments are generating income approaching 50% of your annual spending.

Level 5 also represents a danger point. It’s here that some may become complacent. With so much money saved, it’s easy to return to old habits or to lose focus. Knowing that now will help you avoid this danger when you reach Level 5.

Level 6: 10 years of expenses saved

Level 6 is an important milestone. It’s here that your investment income will begin to equal and then exceed how much you are spending each year.

Let's again assume you spend $50,000 a year. At Level 6, you will have a Freedom Fund totaling $500,000. A 9.3% return will generate returns of $46,500 over the next 12 months, bringing your Freedom Fund to $546,500. The following year, with a Freedom Fund totaling almost $550,000, you will on average generate just over $50,000 a year.

Talk about a great feeling! You are working hard, earning an income, and spending $50,000 a year. At the same time, your Freedom Fund is generating returns equaling the same amount. Like a snowball rolling downhill, your wealth is multiplying before your very eyes.

Level 7: 25 years of expenses saved

Level 7 is the Ultimate Financial Freedom. It’s here that you can completely retire from work if you so choose. Or, if you’re like me, you can work on projects you love while still earning an income. The choice is yours.

When you reach Level 7, you can pursue your passions. That may mean keeping your job. There’s nothing wrong with that if that’s what you love. It may mean starting a business. Here’s the point—you decide for yourself what you’ll do when you reach Level 7. It’s a beautiful feeling.