Updated Sep 2017: A lot of friends and family like this stages of wealth to let them know whether they are improving their wealth progressively. However, the problem for them is that after they achieved Debt Freedom, there is a chasm between Debt Freedom and the next higher rung, Financial Security. In this update I provide 3 more stages that you can aim for in your progression to financial freedom.
Some of the passing comments about money by my friends and relatives drive me nuts.
Perhaps of the structured way I look at things, some of people’s point of view don’t make much sense to me.
One very common one is the definition of Rich.
We define how rich one of our friend, a couple we met or a relative we have by different measures.
Here is some of the ways we defined our friends and family as rich:
- “She doesn’t use a coupon to get a discount for her fast food when the coupon is there for her, because she is rich.”
- ” They can afford to have 4 children, therefore they are rich”
- “They work in government civil service, they are much richer than us”
- “He drives a continental car and fetches her to work, he is rich to be able to afford that”
- “The family goes for 3 holidays a year, one that is non-southeast Asia, they must be rich”
- “If he can buy that 3 bedroom condo he must be rich”
- “He plays the stock market, he must be doing damn well”
One thing you realize is that, many people perceived us as being rich when we show our wealth on the outside to them.
This can be deliberate or accidental.
For example, I do not meant to brag but I have an interest in nice watches. My watch cost $5,000.
Those friends who are familiar with watches will think that I am rich.
If you have a big ego like me, you will feel very satisfied. If you are less of a show off, you be very embarrassed by this comment (like most Asians are)
We will then discuss that having a $5,000 watch is not rich.
There is a Better Way for You to see How Much Wealth You Attained
I do agree you cannot judge whether you are rich or not by a mere $5,000 watch.
I believe a better way to measure the tangible and intangible wealth is through tabulating our:
With this 2, we can figure out how much we hold after debt and how much positive net cash flow we have consistently.
Suppose we are discussing a common friend of ours Jacky, who is doing quite well.
If Jacky has a net worth of $350,000, how rich is that?
How rich we are needs to take into consideration the amount of our net worth and our cash flow, versus the utility of our net worth and our cash flow.
If you have SG$25,000, in a developing country, this would be a lot of money. Your maid in a developing country will imagine the lifestyle SG$25,000 can afford her in Myanmar.
However, to you, SG$25,000 can be spent on 4 things easily.
Most of your friends will focus on the ostentatious aspect of our lives.
I believe we need more fundamentally sound yardsticks or measuring gauges to rank whether we are doing well financially.
A good ranking allows us to:
- Measure how far we have progressed in our wealth building journey
- Compare the wealth of the people around us, to a set of sensible utility (if we want to compare, which is not a very healthy behavior)
Instead of comparing against others (#2), we should be financially aware and see whether we are doing OK in our wealth building journey (#1). (Read my Wealthy Formula, which dissect the common aspects gurus all talk about on how to become wealthy)
In this article, we listed out 11 different stages of wealth that a family or a person can be in.
As a wealth builder, we treat wealth building as a life journey and progress from Stage 0 to Stage 10.
I wasn’t the original creator of this set of milestones. Joshua Sheats from Radical Personal Finance formalize these stages and there is no reason to take and change it when they describe the progression very well.
Let us go through these stages one by one.
Stage 0: Financial Dependent
A person at this stage, to put it simply have a lot of baggage.
Firstly, he or she has to depend on others for survival, for extravagant things or to take care of daily expenses.
Net Worth (Equity) = Assets – Liabilities
Net Worth is usually what we use to determine if a person or entity is in a good financial shape.
The Assets are the stuff that:
- Produces current cash flow or potential to produce future cash flow. You as a human capital, investments, savings, insurance savings, investment bonds and properties are some examples
- Have a value that you can sell off in exchange for money. The value will depend on how much people are willing to pay for it now. This can be whatever value that is left of the car, the home, your stamp collection, your collectibles, your gold and silver coins
The Liabilities are
- Mortgage Debts that is outstanding you took on your home
- Mortgage Debts that is outstanding that you took on your investment properties
- Debts that you borrowed as part of a leveraged insurance savings plan
- Credit Card Debts that you have outstanding
- Unsecured Debts that you borrow from a money lending agency (legal or not legal)
- Debts that you borrow from family members, friends and relatives
- Debts on the purchase of your car
A Financially Dependent person have a negative net worth meaning the assets that he has is less than the liabilities.
A Financially Dependent person has to borrow consistently from banks, institutions, friends and family for the lifestyle that he or she lives.
You might see him always driving the newest cars, switching from a HDB flat to a condo and bringing his family to European holidays for 3 years in a row.
If you assess his net worth it might be a different story.
Secondly, a financially dependent person is unable to keep his cash outflows below his cash inflows.
Net Cash Flow = Cash Inflow – Cash Outflow
Cash Inflow are:
- Disposable Income
- Dividend Income from Dividend Stocks
- Business Income from Side Businesses
- Interest Income from bank savings, deposits
- Cash Payout from insurance savings endowments
- Systematic annual selling of investment assets
Cash Outflow are:
- Basic Survival Expenses.These are the expenses that without them, you and your family can’t survive well
- Rich Living Expenses. These are the expenses that you do not need to survive but they make your life feel RICH
- Repayments for Liabilities
A Financially Dependent person is likely to have a net cash flow that is negative.
How can a person spend out more than he or she earns?
Because you can borrow from others. You can get your family to pay for your house or give you an allowance. The latter is a good situation to be in.
But is the person DEPENDENT on others?
Yes he or she is.
When you are dependent on others, the person have some hold over you.
In this case, they are your friends, boss, company and the banks. If they are not happy about something, they can push that situation to you to create stress in your life.
Can a person be having a positive net worth yet net cash flow negative?
Yes. The person may have assets that is of value, but his family members are servicing his assets.
He may also have lost his job, move on to a lower paying position, but still keeping his cars and big house, but having a very problematic time servicing his home.
Can a person be having a negative net worth yet net cash flow positive?
Yes. The person owes some debt, but he is keeping within payment which is a good thing. The person may be making a conscious effort to pay down the debt or to build up the assets.
He could be taking on debt for studies so that he can earn more in the future.
These are good debts.
But is the person dependent on banks or family members at this point? Likely yes.
Financially Dependent can be good or can be bad, we are not demonizing people at this stage. It depends very much on what the person builds up in his assets.
Stage 1: Financial Solvency
If a financially dependent person proceed to improve in how he or she manages the wealth, they become Financially Solvent.
When they achieve Financial Solvency:
- Their net worth can still be negative, but they stop taking on more money from unsecured lending, friends and relatives or parents
- They are not behind on their liabilities payments. This means their net cash flow is positive.
A person that is financially dependent and progress to this stage shows either higher motivation, a change of their money beliefs and values, a more conducive environment that assisted them to realize they need to be more responsible.
As their net cash flow is positive, they can start putting money away to building wealth, paying down more debts or saving for some goals.
Stage 2: Financial Stability
A person proceeds to achieve Financial Stability when they manage to build up some emergency funds.
A person’s emergency fund, is more important then paying off all his or her debts.
Without the emergency fund, a financially solvent person would be paying off his debts with all his net cash flows and one hospital emergency, and he would have to turn to his credit card or other family members for help.
An emergency fund of $3000 helps a lot, even if it is not the full amount we usually recommend.
To find out how an emergency fund works and how to build it up, you can read this comprehensive guide that I wrote.
A person that achieves Financial Stability tends to have achieve Financial Solvency as well.
Stage 3: Debt Freedom
Debt Freedom is achieved when a person is able to pay off all his or her debts.
That seems drastic because for most people, their mortgage is 25 to 30 years, which means that it will take a long time to be free from debt.
However, we tend to consider Debt Freedom to be achieved when the person paid off all their high interest debt except mortgage debt.
Mortgage debt due to the duration and that the banks can foreclosed and sell off your place, tend to have the lowest interest, and essentially a dwelling is important to some for stable family building.
A person that achieves Debt Freedom tend to have achieve the previous 2 stages as well.
Stage 4: 1 Year F-U Money
You have cleared most of your outstanding debt that are high interest, leaving you with the low interest mortgage debt.
It is time to start accumulating wealth.
You can follow my Wealthy Formula. This is the formula how most people build wealth. The gurus you encountered will say the same thing.
The first milestone in wealth accumulation is to accumulate 1 year of F-U Money.
F-U Money is… a rather crude term. However, I find it difficult to come up with another term that is more appropriate in our urban culture.
F-U Money is Fuck You Money.
It is made popular in urban culture of having $X so that you can fire your boss, tell your company off.
Basically, you have more control over your situation versus when you are a slave to debt and your job.
Suppose last year, you spend about $25,000/yr in expenses.
The first wealth accumulation is to build up this $25,000.
Once you attained this, you have a little optionality. Suppose you think there is much more to your capacity if you leave this job and focus on a separate work domain.
You can make this fork because you are alright for one year.
Stage 5: 5 Years of F-U Money
This is similar to Stage 4, but with a larger build up of F-U Money.
Suppose your annual expenses still hovers around $25,000/yr. If you achieve $125,000, you might be able to take that sabbatical for 2 years, then come back to work.
Alternatively, it can be viewed as you got a 5 year extension to make some life or work projects work.
Stage 6: 10 Years of F-U Money
Stage 6 builds upon stage 4 and 5.
It is a larger sum. So you try to build up 10 years of your expenses.
Suppose your annual expenses hovers around $25,000/yr. If you build up $250,000, you have ample room to maneuver.
The difference between this stage 6 and stage 7 is that, stage 7 requires your wealth machine to provide a cash flow, while leaving the capital intact, stage 6 looks as though you will spend down your principal capital.
10 years of F-U Money is much synonymous with a couple building up money so that one spouse can be a stay at home mom for 10 years.
Stage 7: Financial Security
As you accumulate wealth, your wealth can be put into financial assets that you can manage competently.
We call this your Wealth Machines.
When the person develops these Wealth Machines, their wealth fund would grow and be able to distribute wealth cash flow either by selling off assets systematically, or in the form of interest income, dividend income, business income.
Financial Security is reached when your Wealth Machine(s) is able to provide a wealth cash flow that is greater than your annual survival expenses.
The annual survival expenses is not all your current expenses, but is the minimal amount that, with this set of expenses paid, the family does not go hungry and can live on.
There are no luxuries or rich living here.
For example, your annual expenses is $25,000/yr. However, out of this $25,000, your survival expenses is $14,000/yr.
If your wealth machine can provide a rate of return of 7%, out of this, you can take a wealth cash flow of 5%.
You will need to accumulate $14,000/0.05 = $280,000.
With $280,000 you reach some sort of financial security. You keep your capital relatively intact, while you can conservatively cover your annual survival expenses.
Financial Security is a stage that is very attractive because it gives a person optionality.
It enables the person to make a riskier career move without worrying too much about the repercussions, take a break from work, or pivot to semi-employment.
The person is one who do not have to give a crap about how the boss thinks when his basic survival is not determine by the moods of his or her boss.
Financial Security, in the Financial Independence space is also known as LEANFIRE.
LEANFIRE stands for Lean Financial Independence Retire Early.
Instead of aiming for the wealth assets to be able to provide a wealth cash flow that covers all your annual expenses (stage 8 later), LEANFIRE aims to achieve this by covering their basic necessary expenses, with less money.
Stage 8: Financial Independence
Stage 8 is a progression from Stage 7.
Financial Independence happens when your Wealth Machine(s) is able to provide a wealth cash flow that is greater than your annual current expenses.
Building on the previous example, suppose your annual expenses is currently $25,000/yr and that you believe you can maintain your annual expenses around $30,000/yr plus inflation, you can calculate how much you need.
The formula is the same as my article above on how much you need to achieve financial security, independence or retirement.
If your wealth machine can provide a rate of return of 7%, out of this, you can take a wealth cash flow of 5%.
You will need to accumulate $30,000/0.05 = $600,000.
We can rate a person having an Audi as rich, but to me if a person has an investment property and a portfolio that provides a wealth cash flow covering what he and his family needs now, that is truly a position to be enviable.
Stage 9: Financial Freedom
Once you are past stage 7, the rest is the stuff of fairy tales.
Financial Freedom happens when your stable of Wealth Machine(s) is able to provide more than your annual expenses but also one or two extravagant things that have previously not considered.
What is life if you slog so hard and not get to enjoy?
When a person reaches financial freedom, he can throw in a few things that they have denied their family for the longest time, be it the premium car that they wanted, or one more holiday for the year.
The difference here is that these new spending goals weren’t a consideration before this stage of their lives.
Stage 10: Financial Abundance
The last stage of the list is Financial Abundance.
A person and his family is really rich when, his net worth is very positive, and his wealth machine(s) provide a level of cash flow that expenses accountability can take a back seat.
This is to say that the cash flow is so strong that they can provide for the family and other goals that money doesn’t run out easily while at Financial Freedom, careful considerations still has to take place.
When your friends or yourself have reached this stage, you are probably at the top 1% of the place that you live.
It is likely you will not have an issue sending your niece to an overseas education out of goodwill, throw an extravagant birthday bash for your daughter’s 21 year old birthday or help fund that poor family that got into trouble whose story was all over the newspapers.
Financial Success is a Journey with Many Pit Stops
My friends often get demoralized because they felt to get to where they desired, the journey is too far to travel. So they do not embarked at all.
If we treat financial success as a journey with many markers to tell us whether we are on track, it will be better. This is because even if you do not reached Financial Abundance (which honestly many would not), you will get to a financial position that is more fundamentally sound then where you are.
After showing these 11 different stages, you will realize that it is easier to infer wealth from material goods then this meter gauge.
It will take some probing to find out some of the things that people do not want to discuss about:
- their debt
- their negative cash flow
- how much they purchase the assets at
A positive net worth and a negative net worth not to mention the strength of a person net cash flow shows stability, security, optionality.
This also means there may be more to that story then what we see on the front.
You might be richer than the person for all you know.
On an individual level, how do you measure in this 11 stages, has anyone achieve some sort of financial stability, debt freedom or financial security yet?
Let me know.