Stage 1: Dependence
One classic quote from the Cosby Show illustrates the reason why most children—even those from well-to-do families—aren't independently wealthy. When teenager Vanessa announced that her life might be better "if we didn't have so much money," her father responded "Your mother and I are rich. YOU have nothing!"1
The "dependence" stage of financial freedom can last from your childhood and teen years even into your adult life. If you rely on a parent, a significant other, or someone else to pay your living expenses, you're in this stage. Fortunately, as soon as you become solvent—that is, when your income exceeds your expenses—you've moved on to stage 2.
Stage 2: Solvency
Solvency comes when you're able to meet your financial obligations on your own. (If you're partnered, you can still be considered solvent even if your partner's income is necessary to meet your total household expenses—since you're supporting two or more people instead of just yourself.)
Stage 3: Stability
You'll transition from solvency to stability once you've created an emergency fund of a few months' expenses, repaid high-interest debt, and are continuing to live within your means. While stability doesn't require you to be debt-free—as you may still have a mortgage, student loans, or even credit card debt—you'll have a savings buffer to ensure that you won't go into debt if you encounter an emergency or unexpected expense.
Stage 4: Security
You'll feel financially secure once you've eliminated your debt (or have enough assets to pay off all your debt) and could weather a period of unemployment without worry. At this point, money is not just a safety net, but also a tool you can use to build the future you've been planning. At this point, you may consider investing in other assets besides retirement accounts — a taxable account, rental real estate, or even your own small business.
Stage 5: Independence
Once your investment income or passive income is enough to cover your basic needs, you've achieved financial independence. A financially independent person can retire at any time without worrying about how to cover their costs of living, even if they may have to downsize their lifestyle a bit.
Stage 6: Freedom
The line between financial independence and financial freedom can be a fine one; for many, it's simply the difference between having enough to cover your needs or having more than enough. Once you have financial freedom, you don't need to pinch pennies (unless you want to), and you can take more risks with money you're willing to lose.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments.
All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy.
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