Using a Personal Financial Pyramid is a great way to understand how to plan for your financial future because it structures your financial health and financial growth in a way that helps you take care of the basics while also helping you achieve your midterm and long-term goals.
The pyramid’s base is composed of four elements you need for daily life:
Cash Flow: The money you need for your daily living expenses includes funds to pay your rent or mortgage, purchase food and supplies, and pay for your utilities.
Insurance: The base of your pyramid also covers all your insurance expenses such as the premiums on your home insurance, car insurance, medical/dental, long-term care, and life insurance. You should also consider having disability insurance as part of your shield. Though most people are eligible for Worker’s Compensation, the amount you’ll receive in case of a physical disaster won’t be a lot and will probably be insufficient to handle your monthly costs when you’re not able to work. If something happens that prevents you from working and you wind up in rehab for six months or a year, your family will need sufficient revenue until you can return to work. The price of this insurance is less costly than suffering without income for a lengthy period of time.
Discretionary Funding: In the base, such items as household supplies, clothing, cell phones and entertainment can be included as extras if they are reasonable and not too much of a splurge.
Your Emergency Fund: This segment of the pyramid also includes your emergency fund so you have money you can use when the disaster arises and won’t have to dip into your investments to rescue yourself. Protecting your wealth is as important as creating it because the future, by definition, is unknown.
Remember it’s important to retain your money for more important purposes than squandering cash on your daily $5 cup of coffee. Every dollar invested at 10% becomes $8 in 21 years and because of inflation, every dollar today may only buy a third of what you’ll need in the future.
The Pyramids Core:
The middle section of the pyramid focuses on helping you build your wealth and includes three types of investment portfolios:
Short-term Investment Portfolios: Your short-term portfolio is where you save money for short-term needs such as your annual vacation, to replace an aging appliance, or to buy an extra car for your high school aged child. Otherwise, short-term investing is generally considered risky or a misuse of your investment potential.
Midterm Investment Portfolios: These portfolios are for expenditures that are about 3-5 years away. This category includes such things as your child’s college fund, your daughter’s wedding, and maybe installing a new bathroom in your home or repairing the roof. Investments for this mid-time range should be in conservative funds so you’re generally assured the funds will be there when you need them.
Long-term Investment Portfolios: These portfolios are intended to secure your financial future. The more time you have, the more risk you can reasonably absorb. We’ll discuss the topic of risk in a future article, but for now, understand that the funds in this category should remain there so you can benefit from the anticipated increase of your funds over time. Time is an ally, and it truly can make your Golden Years golden.
The Top Of Your Pyramid:
At the tippy-top of your pyramid are funds reserved only for discretionary investments, specifically those investments that have a magnified element of risk. This means these funds may or may not provide the investment returns you seek, and because of their insubstantial nature they are at the top of the pyramid and only come into play when your basic and core investment needs are thoroughly satisfied.
Discretionary investments can focus on a certain global region that’s politically unstable but has growth potential, or an industry sector such as technology which has accelerated advances and declines; or futures and commodity funds where value changes rapidly and is extremely sensitive. These examples of discretionary investments all have high volatility with high risk and they should only be funded when your financial strength is secured by the lower two sections of your pyramid. Of course, if you don’t have the stomach for a discretionary investment account, that’s okay, too.
Your Personal Financial Pyramid is a great way to target your financial goals at different levels of needs and time frames. If you’d like to establish a Personal Financial Pyramid, or if you’d like us to review your retirement plan and your financial investment strategy, please give us a call. We believe we can help you achieve the financial future you have in mind.
Joseph M. Maas, CFA, CVA, ABAR, CM&AA, CFP®, ChFC, CLU®, MSFS, CCIM
Synergy Financial Management, LLC
13231 SE 36th Street, Suite 215
Bellevue, WA 98006