Unless you’ve inherited vast wealth, the path to financial freedom is gradual, incremental and most likely not linear. That said, financial freedom is wholly subjective, and each person needs to define for themselves what form it takes and what it looks like for them.
From being wholly financially dependent to achieving abundant wealth, here are some insights into the various steps toward financial freedom.
1. Dependency and indebtedness
For most of us, the start of our financial planning journey finds us dependent, wholly or in part, on someone else. If you’ve just started your career, you may be receiving some financial assistance from your parents and battling to bring your expenditure in line with your earnings. With no assets, zero emergency funding, possibly a student loan and some consumer debt, this can be an incredibly frustrating period as you attempt to navigate a way forward financially and find a way to bring your spending below your earnings. This stage is also risky as you may need to incur more debt in order to set yourself up with basics. With no emergency funding in place, you also run the risk of having to incur more debt if faced with unforeseeable expenses. In this phase, your lifestyle will be frugal with no wiggle room in your budget for luxuries, although you run the risk of going into debt to pay for a lifestyle that you simply cannot afford. Using debt to cover lifestyle expenses is simply not sustainable so this should be avoided at all costs. With no surplus income, saving and investing is not possible and, unless you enjoy group benefits, it is unlikely that you will be able to afford an income protection benefit.
Financial planning priorities: Debt reduction, emergency funding, income protection
2. Solvency
As your earnings increase and your consumer debt decreases, you should be able to start spending less than you earn which, in turn, will create room in your budget to start creating an emergency fund. Budgeting will remain tight and, because you’re living from month to month, it is unlikely that you’ll be able to afford any extras. While your consumer debt is under control and you’re paying off the minimum monthly amounts or thereabouts, you’ll probably not be in a position to attack debt aggressively – and your personal finances may be a source of anxiety for you. In this phase, it’s important to remain focused on keeping your expenditure below your earnings, adhering to your budget, and squirrelling away as much as possible into your emergency fund.
Financial planning priorities: Develop a financial plan, continue building your emergency fund and prioritise debt elimination.
3. Stability
Financial stability is generally achieved once you’ve eliminated your consumer debt and built up a cash cushion that can provide for between three and six months’ worth of expenditure. While budgeting is still imperative, there is likely some breathing room in your budget for luxuries, and you’ll probably find yourself less anxious about your financial position. If owning property is part of your plan, your solid financial track record should help you secure financing so that you can leverage your position by entering the property market, although be sure not to over-extend yourself when buying your first home as there are a number of hidden costs associated with home ownership that need to be factored into your budget. It’s also likely that you’ll be required to put adequate life cover in place as security for your home loan, and at the same time adjust your other insurance benefits in line with your changed circumstances. With sufficient emergency funding in place, it’s probable that you start investing for your medium- to long-term goals, even if affordability prevents you from investing at the most tax-efficient level.
Financial planning priorities: Pay off your home loan, set up an access bond facility, ensuring that your income protection benefit is aligned with your living costs.
4. Accumulation
The wealth accumulation phase generally requires more robust and strategic financial planning as you intentionally work towards achieving financial freedom. With higher levels of income and a well-crafted financial plan, your financial goals should feel within reach, and you should feel confident in your ability to create sustainable wealth. During this phase, it’s likely that you have a well-diversified investment portfolio that is fully aligned with your short-, medium- and long-term objectives. You’re probably in a position where you can pay off your home loan aggressively, maximise your allowable retirement fund contributions, and invest towards a flexible discretionary portfolio – while also having extra for luxuries and extraneous expenditure. With sufficient risk cover in place, you’re probably less stressed about the impact that unforeseeable life events may have on your personal finances. With a more complex financial portfolio, estate planning should be imperative to ensure that all aspects of your portfolio are appropriately structured to achieve their purposes.
Financial planning priorities: Investment management, tax planning, structuring of risk cover, retirement planning.
5. Choice
While you still need to work and generate an income, this phase of the journey will likely allow you the luxuries of time and choice. With all debt being settled, your portfolio is now geared to achieve financial independence. This stage could provide you with greater work flexibility, the freedom to take extended leave or possibly even a sabbatical, or the ability to travel more extensively. This is a time when you’ll be able to tick off your bucket list items more frequently, indulge in more luxury expenditure, and possibly buy lifestyle assets such as a holiday home, farm or boat. You may be able to take greater occupational risks such as making a radical career change, setting up a new business, or investing in a start-up. With greater net worth, your need for life and disability cover may reduce so reviewing and assessing your need for long-term insurance should be a priority.
Financial planning priorities: Estate planning, risk cover reduction, business planning.
6. Independence
Once you reach this phase, the income that you generate from your investments should be sufficient to cover your basic living expenses for the remainder of your life. Essentially, you no longer need to work to generate an income and you can ‘retire’ in the true sense of the word. Although your retirement plan is sufficiently stressed tested to ensure that you won’t outlive your capital, you will still need to adhere to your post-retirement budget, review your investment strategy regularly, and possibly adjust your drawdown levels. You have invested sufficiently for a basic retirement with some extraneous expenditure, but your living costs need to be carefully managed and luxury expenditure needs to be intentional and contained. Estate planning remains important as you will want to ensure that your estate is appropriately structured to reduce taxes and maximise any financial legacy you intend to leave for your loved ones.
Financial planning priorities: Estate and tax planning, regular retirement plan reviews.
7. Freedom (and possibly abundance)
Upon reaching absolute financial freedom, you will have sufficient invested wealth to provide for your dream retirement without ever depleting your capital in real terms. With more wealth than you can spend in your lifetime – even if you were to live a lavishly extravagant lifestyle – the interest from your investments will be sufficient to fulfil all your retirement goals regardless of where or how you choose to live. You will never be faced with a situation where you need to realise an asset in order to cover your living expenses and you will not be required to take excessive risk with your investments. Being more than adequately funded for any eventuality that may befall you, you can comfortably afford to give away some of your wealth during your lifetime – whether to your loved ones or to achieve more altruistic goals. With vast wealth and greater complexities, you will likely have a more complex estate plan than most which will need to be reviewed frequently.
Financial planning priorities: Estate and tax planning
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