Personal Finance

The 5-Rung Wealth Ladder: How to Climb Your Way to Financial Independence

Expertise: Real Estate Investing Basics, Personal Development, Business Management, Personal Finance
49 Articles Written

My entire working career (12 years) has been in the arena of real estate investing. More particularly, all of my real estate investing efforts have been focused on the big picture goal of achieving more and more financial independence.

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So, in this article I want to give you a big-picture blueprint, or a 5-rung ladder, to climb and achieve financial independence using real estate investing. Although I am biased, I believe real estate investing is one of the best tools possible in the journey towards financial independence. I hope you can find yourself somewhere along this ladder and use it to continue making your own climb.

The 5-Rung Ladder to Financial Independence

Rung #1: Support Yourself Financially

I like to imagine that this 5-rung ladder is on the side of a big pool or a body of water. Before we begin climbing, we are furiously swimming and treading water with lots of big waves and sharks threatening to pull us down. The first step, then, is just to climb on the ladder and get out of the financial danger zone.

Financially, this first step is to figure out a way (or multiple ways) to support yourself and your family. You’ve got to get good at consistently being able to pay the bills. Sadly, most people get stuck going back and forth from the water to this step for their entire lives.

Related: Of These 4 Financial Paths, You Can Only Choose One. Does Yours Lead to Financial Freedom?

There are two broad paths you can take to earn income for this step. First is the path of employment. Second is the path of self-employment or entrepreneurship. I took the second path from the beginning, but a large majority of people take the path of employment. You can also do both at the same time by starting a side business . There is nothing wrong with any of these choices. People have reached the top of the ladder with all of them.

Whether you are an employee or an entrepreneur, the degree of financial security you have on this first rung is directly related to the amount of value you can add to the marketplace. You can ensure that you are personally valuable by investing in your #1 asset: yourself.

Commit to constantly improving your trade skills, your knowledge, and your communication abilities. Also commit to an optimistic, can-do attitude. Complainers, worriers, and victims are annoying and commonplace. Those of us who take responsibility for our own lives are rare. Rare is interesting and valuable.

I write about this often (“How to Win the Financial Survival Game“), but this first rung is not only about earning more consistent income. It’s also about ensuring the pockets where you put your money don’t have holes in them. If you can just keep your personal spending at a reasonable level, you will not have to work as hard to stay on the first rung.

Rung #2: Become a Saver

If you earned $500,000 per year for 20 years but never saved much money, you would never move from the first rung to the second rung of the ladder. Becoming a saver is a requirement to move towards increased financial independence.

I often quote from an article called “The Shockingly Simple Math Behind Early Retirement” over at the blog Mr. Money Mustache. The main point is that your time to reach retirement (financial independence) is directly related to your savings rate. In other words, the higher percentage of your take home pay that you save, the faster you reach financial independence. The smaller your saving percentage, the longer it will take.

You may love your job or your business now, but if you want to have options to work less, to change careers, or to take a break 10-15 years from now, the first priority is to get serious about saving money.

I set and track savings goals each year. For me, the savings fall into a these broad categories:

  • Personal reserve funds
  • Business/real estate reserve funds
  • Savings for travel and fun
  • Retirement account savings
  • Non-retirement account investment savings

All of these categories are important. They all work together to move you up the ladder towards rung #3.

Rung #3: Buy Investment Assets for Growth and Income

Once you fund your personal reserves and accumulate savings in your retirement or non-retirement accounts, you can begin thinking about how to put that money to work. Savings are like little employees of your financial independence business. Their job is to do work for you and send back profits in the form of equity growth and income.

The core of my personal long-term plan is to own a portfolio of income properties and notes secured by real estate. I’m not the only one who likes this idea. A lot is written on this subject by me and other BiggerPockets authors. If you’d like to get some guidance, I’ll give you a few good articles below to get started.

Whatever specific plan you choose, the basic strategy of this rung of the ladder is this:

  1. Choose a date and an end goal for the amount of income you want.
  2. Work the math backwards and estimate the amount of equity you’ll need in order to produce that income (i.e. $1 million at 6% = $60,000/year).
  3. Start accumulating assets.
  4. Compound for fast growth.
  5. Reach your goal.

With your personal overhead covered by income from assets, you can now move up to #4 and secure your place on the ladder for the long run.

Rung #4: Reduce Your Risk

If you were successful in rung #3, you now have enough income from assets to meet your personal needs. Congratulations! But you haven’t reached the top of the ladder yet. If you are not careful, you could slip and fall back down the ladder.

Another way of saying this is that the more money you accumulate, the more you have to lose. For that reason, it makes sense to become more risk averse as you move farther up the ladder.

Here are some ways to secure your position on the 4th rung and reduce your risk.

Pay Off Debt:

I like to own free and clear notes and income properties. When at least a part of your portfolio is free and clear, that portion is immune from the risk of default and losing the assets to a lender. Leverage is a great tool for growth, but at some point it is smart to grow beyond needing too much of it. There is a reason the wealthiest people and companies have a relatively small amount of debt relative to their net worth. It adds unnecessary risk.

Sell Under-Performing Properties

As you climbed rungs #1-3, it’s likely you accumulated at least a few properties that don’t perform well enough financially. It’s possible the operating expenses may have been higher than expected. Perhaps the taxes went up, the maintenance was a lot higher, or the insurance premium went up for some reason. Selling the under-performing properties and exchanging them with better ones can optimize your passive income.

Sell Properties With Toxic Locations or Tenants

If you’re like me, you probably acquired a few lower-priced properties that had “incredible” cash flow. The problem, as the experienced investors know, is that these properties come with a lot of baggage. First, they are more time-intensive to manage because tenants turn over more often and have more financial drama in their lives.

Second, these properties often don’t make the money anticipated in the beginning (See Ben Leybovich’s article, “You Can’t Make Money on $30,000 Houses“). Third, these properties expose your entire portfolio to liability from tenants who would be more than happy to sue you. Fourth, owners of these properties tend to burn out over the long run.

The moral of this story is that if you already have enough income from assets to pay your bills, why mess with all of this? Sell, trade, beg or whatever you have to do to get rid of them!

Focus on Asset Protection

This area is not my specialty, but this is a very important idea to focus on. A basic principle will be not to put all your eggs in one entity basket. You'll need to find reasons other than asset protection to separate them, but you might do that by location, price range, or property type. You can also talk to a good insurance agent to make sure you have enough insurance liability protection. This is an important and complex subject, so studying and learning from attorneys and other experts is crucial.

This rung of the ladder was about securing your principal and reducing hassle. The next and final rung is about hedging for uncertainty.

Rung #5: Hedge Against the Unpredictable

If you’ve moved all the way to the top of the ladder, you now have solid assets, you’re receiving a healthy income, and you’ve taken steps to reduce risk. What else is there to worry about financially?

One answer is uncertainty. While falling all the way down the ladder is less likely at this point, major economic trends like inflation, deflation, and other unpredictable events can erode the overall effectiveness of you portfolio.

One of my favorite old-school real estate teachers was Jack Miller, an investor from Florida who passed away a few years ago. Jack suggested a “3-Legged Stool” strategy to hedge against the unpredictability of the future over the long-term. Here are the basics of his 3-legged stool strategy:

  1. Hedge for Deflation: Jack’s favorites to help in this category were free and clear income properties in the median price range of a market, long-term leases to solid credit tenants, and variable rate mortgages secured by excellent collateral.
  2. Hedge for Inflation: Jack's favorites here were highly leveraged rental real estate (to short the dollar) in demand locations, with fixed rates, and over long-terms. He also liked variable rate mortgages with short-terms that allowed him to adjust interest rates up.
  3. Hedge to Provide Flexibility: The truth is that no one really knows when certain events will happen in the future. So to remain flexible, Jack liked to always have a significant portion in assets that can be easily converted to cash. This includes cash in checking/savings accounts, money markets, gold/silver, stock funds, and highly discounted real estate notes.

The Purpose of Financial Independence

So, we’ve made it to the top of the ladder to financial independence. Congratulations. Aiming towards and progressively achieving more financial independence is a worthwhile goal.

Related: The Power of Passive Income: How to Free Yourself From Your 9 to 5

Now that you are mentally at the top and you are reflecting on the “how” of achieving financial independence, it might be a good time to also think about the “why.” You may have heard that sometimes people climb ladders for years, only to realize that they were climbing to the wrong destination.

So, why are you making your own climb? Is it for added security for you and your family? Is it to earn the respect of others (or yourself)? Is it so that you can contribute more to others using your time and your money? Is it because your job is sucking the life out of you and you want to gain control of your time and your life?

All of these are valid reasons, and I’m not trying to give you a right answer. But I do know that the energy and drive of your own personal “why” will keep you climbing even after inevitable setbacks and delays.

Good luck and happy climbing!

What is your “why” for climbing towards financial independence? Where are you on the 5 rungs of the ladder? If you have already made it towards the top of the ladder, what have your own experiences been like?

I’d love to hear your comments below.

Chad Carson is an entrepreneur, writer, and teacher who used real estate investing to reach financial independence before the age of 37. He wrote an Amazon bestselling book
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    Andrew Cordle from Alpharetta, Georgia
    Replied over 5 years ago
    I agree, real estate investing is a great way to achieve financial independence.
    Julie Hassett Rental Property Investor from Glen Arm, MD
    Replied over 5 years ago
    My “why” is to be able to easily support my parents to whatever degree they require to live happy, comfortable retirements.. to visit one new country every year… and to be able to hire full-time help when I have children! Some great advice I got once was that the world is like a gigantic arcade. How many games you get to play depends on how many tokens you have. I took that to heart. For me, it’s a lighthearted but very poignant way of relating to money and wealth. Great post! Thank you!!
    Chad Carson Investor from Clemson, SC
    Replied over 5 years ago
    I love the game and token analogy. And I like the fact that it makes the whole financial climb fun and like a game. It doesn’t have to be so serious, right?:) Inspiring why. Thanks for sharing.
    Replied over 5 years ago
    Great post, I’m on step 4 thinking more and more about step 5 – so thanks for the 3 leg stool strategy (I haven’t seen that before). It is fun when the portfolio starts rolling under its own steam.. After 8 years of holding rentals and notes, just used cashflow on living expenses for the first time.
    Chad Carson Investor from Clemson, SC
    Replied over 5 years ago
    AJ, congrats on making it up to rung #4! What an accomplishment to be able to use that rental and note cash flow to pay the bills! The three leg stool is a helpful analogy. I think everyone will choose their own mix, but the point is to balance that mix out and not lean to heavily on one leg or another.
    Gloria Dulan-Wilson from Philadelphia, Pennsylvania
    Replied over 5 years ago
    Chad – as a not-so-new-newbie, I’m still learning all I can – and you’ve given me a great perspective in reference on how to direct my focus in this move toward wealth – thank you
    Chad Carson Investor from Clemson, SC
    Replied over 5 years ago
    Thank you Gloria! I am with you – always learning as much as I can. I’m happy the article helped with your focus and next steps. What are you currently working on in your own climb?
    Michael Seeker Investor from Louisville and Memphis, TN
    Replied over 5 years ago
    Great article, I’ve already bookmarked and am planning to share as well. The only thing I think that might be missing is a stronger nod to diversification around rung 4 or 5. You mentioned buying rentals in different locations and price ranges and paying down debt (which I totally agree with). But there’s no discussion about other asset classes. There are plenty of other income generating asset classes (commodities, equities, etc.) that are also cyclical like real estate and can be bought at great discounts towards the bottom of cycles.
    Chad Carson Investor from Clemson, SC
    Replied over 5 years ago
    Hey Michael, Thanks for the bookmark and the shares! When articles get to 2,000 words, I have to cut it off from becoming to much. I couldn’t agree more that we could talk a lot more about diversification with other asset classes. I’ve moved into more equities myself through low-cost index funds. I haven’t done anything with commodities or other asset classes. Which ones would you recommend looking into more?
    Presley Reeves Investor from Wlmington, North Carolina
    Replied over 5 years ago
    Thanks Chad! I believe your mention of hedging risks is relevant now. We know that interest rates have no where to go but up, and inflation could rear up as well. Both are important for real estate. I don’t believe many investors today know what double digit mortgage rates, and wild inflation does to the real estate market. Things will change, we just don’t know when.
    Chad Carson Investor from Clemson, SC
    Replied over 5 years ago
    Thanks for the perspective, Presley. For those of us who have never lived through double digit mortgage rates and wild inflation, all we can do it learn from history. I certainly don’t have a crystal ball anymore than the next person, but like you say it sure seems to make sense to prepare at least part of your portfolio for economic conditions that we have not seen since the early 1980’s.
    Kerry Baird Rental Property Investor from Melbourne, FL
    Replied over 1 year ago
    I realize this is a well-seasoned article, but it is still Solid GOLD.