There are 5 milestones that help you achieve financial freedom. You need to get to Level 1 before go to level 2 and vice versa. The levels are:
- Level 1 – Financial Protection
- Level 2 – Financial Security
- Level 3 – Financial Independence
- Level 4 – FinancialFreedom
- Level 5 – Absolute FinancialFreedom
Level 1 – Financial Protection
Financial Protection is achieved one you have 6 months worth of cash to meet all basic needs to survive without anybody need to go to work. So, if something bad happened, you have full 6 months to back to your feet again but continue your life as it is. So, what you need to define your level is your monthly cost or overhead.
This include all basic living cost: food, clothes, transport, all bills, insurance, home maintenance, credit card repayment, mortgage, basic entertainment, etc. But no holiday, no saving or other major purchase included. Only everything that needed to continue ‘normal life’
Example: John and Jane requires in average $3000 per month to meet all basic living cost. Hence their level 1 – financial protection is 6 x $3000 = $18.000. So, once they have $18,000 in the bank, they can survive for 6 months without having to work but can still be able to live as normal.
Level 2 – Financial Security
Financial Security is achieved once your investment can produce 12 months worth of all basic living cost. This is not your income from work, but only from your investment such as: profit from share market, profit from your investment business, interest from your term deposit, your rent income from your positive cash flow property, etc. This is a passive income that provide you with financial security
Example: With $3000 mothly cost, then John and Jane’s investment need to produce $3000 x 12 = $36,000 profit per year before they can get Level 2 – Financial Security status.
Level 3 – Financial Independence
Financial Independence is achieve if the investment can produce profit equal to your combined annual salary / current earning. So, at this stage your total income is basically doubled. In other word, income from your investment have produce the same amount of money that you can get from salary or work.
Example: John and Jane have total combine annual salary of $90,000 per year. Then their investment income need to produce $90,000 as well before they can hold Level 3 – Financial Independence status.
Level 4 – Financial Freedom
To achieve Financial Freedom (Level 4), the investment / passive income need to produce not only whatever you get from Financial Independence, but also 12 months worth of all the cost needed to cover the living cost plus all lifestyle and luxury item. All from your investment income. So, at this stage you can cover all the living cost plus lifestyle cost just from passive income derived from your investment. You still have additional earning from your salary / work. But obviously you no longer have to work again.
This additional lifestyle/luxury item can be calculated using the interest payment as if we get a loan to get hold of that item. (i.e: controlling vs owning, see the article)
Example: John and Jane have 3 lifestyle items that they really want to have once they have financial freedom:
- $200,000 boat. With 8% interest, the monthly repayment will be: 8% x $200k * 1/12 = $1334 per month
- Charity $1000 per month
- New house of $1.5 million. Monthly repayment: $10,000 per month assuming 8% interest
- Total these 3 items above is $12,334 per month/$148008 per year plus $90,000 = $238,008
Level 5 – Absolute Financial Freedom
Your investment income have absolutely covered all your expendentiure beyond your imagination. Absolutely everything that you can buy with money in the world. For quantitive sake, let say at least you have 3 times the amount from Level 4.
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