The Three Stages of Financial Independence


Everyone would love to be financially independent, but what does that actually mean? Here are what I consider the three main steps to achieving freedom.

On the path to financial independence, I’ve often been asked if I have a goal in mind. Many people refer to this goal as “your number” – the magical line in the sand when you cross from being financially dependent to financially independent.

I’ve always thought the idea of a single number seemed silly. How could there be one special number that meant I reached the holy grail of financial independence? Life has rarely worked that way so far. Every time I reach a goal, there’s always another on the horizon, so it’s never made much sense to me that financial independence would be a clear “yes/no” proposition.

Regardless of my financial goals, my number is almost guaranteed to be different from your number. Your tastes, habits, and expenses are different from mine. We don’t have the same family. We didn’t start in the same place. That muddies the water even further.

In this article, I’d like to break down how I view financial independence and the various stages of financial independence. Here are the three ways I think about financial independence and how I plan to reach each stage. But, regardless of the three different stages to financial independence, they all have one basic thing in common: You don’t have to work to earn an income because your investment income covers all your living expenses.

Stage One Financial Independence: Median Household Income

The median household income in the United States is $57,617. The poverty line for a family of two is $16,460. If your family is making between $16,460 and $57,617, you are in the lower middle class by definition (although it’s debatable that we should be using the concepts of “lower middle class” and “upper middle class” but that’s a story for a different article).

It would take somewhere between approximately $425,000 and $1,450,000 in savings to reach Stage One Financial Independence assuming you could withdraw about 4% of the portfolio without ever need to touch the principal. This levels of savings would provide you with an income level in the lower middle class (keep in mind that it’s really your expenses that count, which we will soon see, but approximating the median income seems the best measure for Stage One Financial Independence since at this income level there’s not a ton of room for saving money anyway).

If you had an income in this range you would be able to cover all of your annual expenses in the majority of the United States. Your lifestyle might be lower than it is today – and you probably wouldn’t be living in a big city on the coasts – but you would no longer need to work to cover your basic living expenses.

In my view, Stage One Financial Independence is achievable by 99% of lawyers. The speed at which you obtain Stage One Financial Independence will depend on your income but the end result is simply a matter of when and not a matter of if, assuming that you decide to achieve it.

A lawyer that saves $10,000 a year over a 35-year career (from ages 30 to 65) can expect a nest egg of $1,250,000 in inflation-adjusted dollars. I don’t know too many lawyers that can’t save $10,000 a year. If that same lawyer manages to increase her savings rate to $20,000 per year for years 40 to 65 she’ll end up with $1,850,000 in inflation-adjusted dollars, putting her expected retirement income ahead of the United States median household income.

Many lawyers aren’t able to grasp Stage One Financial Independence because they either grew up in expensive areas of the country or are working in expensive areas of the country right now. If you have a portfolio of $1,000,000 generating $40,000 a year in income, it might seem far-fetched to imagine living off $40,000 a year in a city like San Francisco.

Stage One Financial Independence has a lot of flexibility though and is the most important stage of financial independence since it’s the baseline level where you can call yourself financially independence.

Once you reach it, you can do things like:

  • Decide to work at a non-profit for a tiny salary.
  • Explore a risky side-project or business and not worry about it failing.
  • Downsize by moving into a small house or apartment and stop working entirely.
  • Move to a lower cost-of-living location in the United States or somewhere else in the world where you can stretch each dollar farther.
  • Take a multi-year sabbatical to travel the world or spend time with your children between ages 0-5 before they start school.

Stage One Financial Independence is where a Biglaw Associate can find himself after 5-8 years of working. Or, for a household in Kentucky, it’s where they could find themselves after 15 years of saving $30,000 annually (expected inflation-adjusted portfolio at that savings rate would be $725,000). For that Kentucky lawyer, both partners need only use a 401(k) to reach $725,000 since $30,000 a year is less than the maximum space available to them each year.

Stage Two Financial Independence: Current Expenses Covered

If Stage One Financial Independence is the result that 99% of lawyers can expect to achieve in their lifetime, Stage Two Financial Independence is the outcome that confuses them the most. Many lawyers assume that because they’re in their working prime, they’ll never be able to achieve “true” financial independence where investment income is covering their current expenses. Those lawyers forget that they could easily move to other parts of the country and be financially independent.

But let’s dream a little and imagine how much money it would take to cover your current expenses. If you’re following the Biglaw 1st Year Sample Budget, you’ll be spending about $60,348 to live in an expensive city. You’ll also probably be living with roommates, so we’ll call this the low end of Stage Two Financial Independence (note that it’s still higher than the US median salary). If you’re a family of three living in NYC, it’s reasonable to think your expenses could be closer to $120,000 a year.

It would take somewhere between approximately $1,500,000 and $3,000,000 in savings to reach Stage Two Financial Independence assuming you could withdraw about 4% of the portfolio without ever needing to touch the principal. This level of savings would provide you with enough income to cover expenses in a big city.

The funny thing about Stage Two Financial Independence is that it’s still a perfectly reasonable goal attainable by the majority of lawyers willing to work their entire career.

A lawyer that maxes out her 401(k) retirement account by saving $18,500 a year over a 35-year career (from ages 30 to 65) can expect a nest egg of $2,300,000 in inflation-adjusted dollars. Many lawyers simply don’t want to work for 35 years but, if you’re willing to do so, it’s perfectly reasonable to expect to reach Stage Two Financial Independence. If you add a Backdoor Roth IRA to that savings plan, you’ll come out with $2,950,000 in total retirement savings, putting you at the upper range of Stage Two Financial Independence.

I think a lot of lawyers find themselves defeated thinking about Stage Two Financial Independence because the thought of working for 35 years seems like too much. Can you reach Stage Two Financial Independence earlier in your career?

If you’re willing to save $50,000 a year toward retirement, you could cut that working career nearly in half by working from ages 30 to 48 and you’d have an inflation-adjusted expected retirement account of $1,625,000, putting you in the beginning bands of Stage Two Financial Independence.

Saving $50,000 a year towards retirement is a “serious” savings mode, which may be too steep for many (keep in mind this in addition to any other saving you need to do for things like houses, cars, etc.). But it’s certainly possible to reach Stage Two Financial Independence in an early timeframe if you’re motivated. If you have a combined household income of $200,000, saving about 25% of your gross income would put you on course to save $50,000 a year.

Stage Two Financial Independence gives you even more flexibility than Stage One. Once you reach it, you can do things like:

  • Stop working entirely, continue living in your current city and spending the same as you have been previously.
  • Move to a lower cost-of-living location in the United States or world and live like a king, never needing to work again.
  • Explore a risky side-project or business and use some of your capital to help get it off the ground.
  • Have one spouse stay at home permanently while the other spouse pursues other hobbies or interests.
  • Become an artist without ever being concerned about selling your work.

Stage Two Financial Independence is where a super-saver lawyer in Biglaw might find themselves as a junior partner. Or, for a household in Kentucky, it’s where they could find themselves after 35 years of saving $24,000 annually (expected inflation-adjusted portfolio at that savings rate would be $3,000,000). For that Kentucky lawyer, that’s simply maxing out a 401(k) and Roth IRA every year you work during a normal 35-year working career!

Stage Three Financial Independence: Ideal Expenses Covered

This is the level of Financial Independence that everyone wants to achieve. It’s also usually what someone has in mind when they first discover the concept of financial independence. A typical example is a lawyer that decides if they had $200,000 of annual income – without needing to work – they’d be all set. With $200,000 – $300,000 in income, you can live comfortably as a family of four in just about anywhere in the United States or the world.

It would take somewhere between approximately $5,000,000 and $7,500,000 in savings to reach Stage Three Financial Independence assuming you could withdraw about 4% of the portfolio without ever needing to touch the principal.

This level of savings may feel out of reach for most lawyers unless they’re willing to sacrifice a significant amount of current consumption for future consumption. A lawyer saving $40,000 a year towards retirement that is willing to work a full 35-year career could expect to have an inflation-adjusted nest egg of $5,000,000. To bump themselves to the higher end of the range they’d need to save $60,000 a year.

Does this mean Stage Three Financial Independence isn’t attainable? I don’t think so.

The way many people reach Stage Three Financial Independence is through a combination of investment income and investment cash flow acquired later in life. The thing about Stage One or Stage Two Financial Independence is that if you’re motivated enough to reach them fairly early in your life (i.e. before 45), you’re likely the kind of person that will find other ways to generate money in retirement.

Since financial independence allows you unlimited time to pursue whatever you want, many people move up the stages of financial independence once they’re unshackled from working on projects and tasks that benefit someone else more than they benefit themselves.

If you had unlimited time and had reach Stage One Financial Independence, would you be motivated to push yourself toward Stage Two or Stage Three?

Let’s talk about it. What stage of Financial Independence are you shooting for?

Joshua Holt

Joshua Holt A practicing private equity M&A lawyer and the creator of Biglaw Investor, Josh couldn’t find a place where lawyers were talking about money, so he created it himself. He convinces the student loan refinancing companies to give you cashback bonuses for refinancing your student loans and looks forward to you discovering how easy it is to track your net worth with a free tool like Personal Capital.

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    Sixteen thoughts on The Three Stages of Financial Independence


      1. I think that’s right for many people but if you didn’t feel the need to live in Chicago, you probably would be okay at Stage Two or maybe even Stage One. The thing about Stage Three is that it’s easy to brush financial independence aside if you think you need $7.5 million to retire!

    1. I’m at stage 2 and happy to be here.

      Stage 3 would be a possibility if I were to continue working full-time for another decade or so, but I’ve already decided there’s probably not much I would do differently if I were worth twice as much. So now I’m working part-time and I don’t regret the downshift one bit.

      Cheers!
      -PoF

      1. Don’t you think your current investments will probably carry you into Stage 3? I see your possible (eventual?) retirement as an accelerating one since you’ll probably spend significantly less than 4% of your portfolio at first.

        1. You know… there is a very good chance we’ll realize that dollar amount eventually. With the recent slowdown in work and income, it might take long enough to hit that mark that $5 Million will still qualify as Stage 2 by these criteria.

          If this blogging thing really takes of, though…

    2. Would you mind expanding on the following point “Stage One Financial Independence is where a Biglaw Associate can find himself after 5-8 years of working.” I’d like to see what numbers you’re thinking. Thanks! 🙂

        1. Thank you! My bonuses aren’t market and I have student loans (aggressively paying those off), but I think $1 million by 40 is doable. Great content, as usual.

    3. I think this is interesting. How much do you think your definition of Stage 3 is influenced by real estate costs on the coasts in the big cities that many lawyers find themselves in? To my eyes, that impacts how luxurious stage 3 as you have defined it seems. If real estate and property taxes is 60+k annually that changes your view. (Chicago, by comparison, is cheap to these coastal areas, or at least was; i havent checked the stats recently) if real estate expense is gone or a fraction of that i would think Stage 2 would seem pretty nice.

      1. I think Stage Three is partially influenced by real estate costs for sure. You’re right that if you move somewhere cheaper or pay off your mortgage, $200K becomes a lot of money each year burning a hole in your pocket. Many people mistakenly think spending will go up in retirement even though the surveys I’ve read all show that your spending will go down. After taking 2-3 trips a year for 3 years, you might get a little bored with the traveling I guess!

        I wrote this more because I think the concept of Stage Three financial independence is what many high-income professionals automatically think of when they think of “financial independence”. In other words, if I’m making $200K today then I need $5M to be financially independent. That can easily discourage someone from even pursuing financial independence. Luckily, as you point out, they probably won’t need nearly that much to be independent from work.

        1. Great point. The irony though is most high income lawyers, if they can log 25 to 30 years in big law can totally reach stage 3 and retire early. They just have to maintain an upper middle class lifestyle over those years and save the rest. For me, i would feel great with stage 2 if it werent going to demand geo change because of the high real estate costs. Stage 3 would give me optionality to stay put.

    4. So many people don’t realize that the important of being long equities, as early as possible.

      Harder of course if you don’t have an inheritance but still, I’d love to see more college students starting their portfolios in their 20s instead of 30s.

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