It’s tempting to think of “financial independence” as a finish line. You’ve either crossed the finish line, or you’re still running the race.
But financial independence is more nuanced, says today’s guest, Joshua Sheats.
We experience seven stages of financial independence, Joshua says, and we should break down our Major Goal — financial independence — into a series of smaller steps.
Joshua, a financial planner and host of the hit podcast Radical Personal Finance, describes these seven stages in today’s show, offering tips about how to reach each one.
Here’s a sneak peek:
Stage 0 – Total Financial Dependence. Everyone starts here. When you’re a child, for example, you’re dependent on grown-ups.
Stage 1 – Financial Solvency. You can support yourself, without help or handouts from others, and you’re current on your bills.
(Many people think that financial management stops at Stage 1. Our guest Evelyn Connors describes the mindset behind this misconception in Episode 28.)
Stage 2 – Financial Stability. You can support yourself, your bills are current, and you hold some savings.
Stage 3 – Debt Freedom. You’re debt-free, in addition to the points above. It’s your choice whether or not you want to include your mortgage within this definition. (Joshua elaborates on debt paydown during Episode 32 of his show.)
Stage 4 – Financial Security. You have enough investment income to cover basic, bare-bones living costs.
Stage 5 – Financial Independence. You have enough investment income to cover your current lifestyle.
Stage 6 – Financial Freedom. – You have enough investment income to cover BIG dreams and upgrade your lifestyle.
Stage 7 – Financial Abundance. – You have enough investment income that you cannot possibly spend this money. Vast amounts of your money will outlive you, and your focus is wise stewardship of this wealth so that you can leave a beautiful legacy.
(We touched on these seven stages briefly in our interview with J.D. Roth during Episode 20, but we dive deeper into these stages on today’s show.)
How do you traverse these seven stages? And how can you enjoy life while you’re along the journey?
Find out in this thoughtful interview with Joshua Sheats.
— Paula
P.S. About 2/3rds through the episode, listen for Joshua’s startling, counterintuitive advice about contributing to your 401k! Joshua elaborates more on this during Episode 314 of his show.
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Joshua mentions that one of the best investments you can make is developing your ability to earn more.
If you’re an entrepreneur or a side hustler, you’re developing your earn-more-muscles. But you’re also tasked with invoicing and bookkeeping, two tasks that are necessary but doesn’t fuel future growth.
Freshbooks is a online platform featuring an easy, intuitive invoicing system designed for solopreneurs, freelancers and self-employed hustlers. They’re also an enthusiastic supporter of this podcast.
Try them for FREE — no credit card required! — by visiting Freshbooks.com/paula. When they ask how you learned about them, please mention the Afford Anything podcast. Thank you for your support!
Great episode, Paula! Keep up the great work. One of my favorites. As an accountant, I have run through the Roth vs Traditional calculations and as stated on the show, they turn out to be the same if you have the same pre-tax amount to invest (i.e. $5,000) and take taxes out before putting the money into the Roth.
I think the most meaningful comparison is that of a taxable account vs a tax advantaged account (Roth or traditional). There, the benefits of the tax advantage accounts becomes more apparent.
Interesting to consider these stages. It gives a little perspective.
I wouldn’t be too quick to dismiss mortgage debt, especially as most home buyers borrow the maximum amount allowable (which is too much).
For most people at these early stages, a home purchase is a critical decision. It affects short and long term finances, careers, relationships… everything.
I think the general wisdom suggests buying a home is simply the right thing to do, but it is far more complex than that. I would like to see more critical thinking about how best to choose a home to make a more meaningful contribution to someone’s life.
Agreed, Bill. It’s crazy to me how many financial bloggers brush off mortgage debt as an “oh, it’s fine to ignore that one because maybe one day 30 years from now you’ll sell at a profit.” I know dozens of people who bought a house to fulfill some sense of duty to the American dream, only to be put into financial ruin because there was no way they could afford taking out a loan that large (not to mention paying for ongoing maintenance, property taxes, HOA fees, etc.).
Hi Kelly, home purchases go unchallenged as not only acceptable, but smart. If people stay for 30 years, I feel confident that it will have been a good choice and will be worth a substantial sum of money. Of course, that is largely because money becomes worth less each year (inflation) and real estate is a great hedge on inflation. Unfortunately, people don’t stay for 30 years and often pull out equity as it gets built undermining the saving potential of a home purchase.
I like Paula’s approach of simply questioning the wisdom and life impact of a home purchase. She rents, but buys income properties to hold. I believe there are a lot of ways to skin this cat, we just need to think outside the box.
this is by far the best episode. His tirade at the end is really worthy of a “mic drop”. As you said, afterwards, there was nothing left to say.. simply beautiful..
Dave Ramsey says something similar during the end of his book The Total Money Makeover, after the last baby step, in which your money has a life of its own. However, it just wasn’t as well said as Mr. Sheats.
I’m currently in the debt pay down stage. I do have passive investments that currently pay for about a third of my current lifestyle. I do have a ton of student loan debt. This podcast was so motivational, that I can’t wait to deposit my next paycheck to pay off a chunk of that debt. As you’ve said, you can afford anything– just not everything.. so for now, I will focus my efforts on annihilating that damn student loan debt.
The Roth IRA calculation was an eye opener as well. I always assumed that you would get more since you paid the taxes upfront, and then getting to withdraw it tax free at the end. I guess you learn something new everyday.
Can’t wait till the next podcast!!
Great show! I’ve been investing in Roth and other retirement vehicles for about 15 years and recently realized it doesn’t work well if you’re planning an early retirement. It’s on auto pilot so I’m still investing. I plan to stop to use the same money to invest in real estate. This podcast motivated me to take action. Thanks.
I also listened to a few radical personal finance podcasts. Thanks for the introduction.
Wow. So much useful info said so well. One of the best podcasts I’ve listened to. And kudos to Paula for adding value by stopping and getting clarity at key moments. I’ll be listening to this one again!
Paula,
This was one of my favorite episodes yet, so much useful information! I liked how Joshua breaks down the 7 stages more than Dave Ramsey – it’s more applicable to those of us with no plans for a mortgage or kids.
Keep up the GREAT work! Your show is incredibly inspiring.
Kelly
Something I didn’t hear during the Traditional vs. Roth debate is that the tax savings from the Traditional contribution can be invested. I eat my tax savings, but in theory if you avoid paying taxes on the $5,000 that is put in the Traditional, that money that would have gone to the government can instead be invested.
I know he was trying to illustrate the differences in an easy to understand way, but there’s no reason to take out all of the future traditional balance and pay the tax on the entire amount all at once in the first year. You take out the amount needed for that year. So you can avoid paying the hypothetical marginal tax rate of 20% at the beginning. Then, at the end, you can take some money out of the Traditional at 0%, some at 10%, etc.
I think diversification here is important. just as with anything else. Although I give the edge to the Roth, I also have Traditional and Taxable, in order to give myself flexibility.
Paula, I am a fan of your show in general, but I was really disgusted by the bad advice this guy was giving out. I tore off my headphones when I heard him assert that it was a good idea to stop investing in your 401K! because it’s not accessible until later on in life. That is very bad advice and also wrong! The Mad Fientist has published a number of articles that refute this very point. For example: http://www.madfientist.com/how-to-access-retirement-funds-early/
If you could get the Mad Fientist or mr/mrs. 1500 on your show to provide a rebuttal, I think you might be providing a really valuable service to your listeners. Please please, pretty please!!!
Michelle,
Oof! I hope your headphones are ok!
I’ve covered this subject extensively on my show as well, even to the point of discussing how it can be worth it to take early access to 401(k) funds even if you have to pay the 10% penalty. For example: https://radicalpersonalfinance.com/314-can-get-money-early-retirement-using-ira-401k-even-pay-10-penalty/
The 401(k) topic is tricky for a few reasons. An important caveat is that you generally can’t take a distribution from a 401(k) before 59.5 if you are still employed by that company. (You might be able to take a loan against the account.)
As with most financial topics, there’s rarely a “right” and “wrong” path. If memory serves, I was illustrating that money outside of a 401(k) can be far more useful to people than money inside a 401(k) because it gives them more options.
Joshua
Big miss on the traditional vs Roth IRA. Y’all totally forgot that the tax you are savings on traditional is your marginal rate (say, 22% in my case), and the tax when you take it out is your overall rate (closer to 8% in my case). Whereas the tax on the Roth is forever 20%.