If you search the internet, there are many versions of the Financial Planning Pyramid. At the end of the day they all say something similar:
You shouldn't spend your time equally on all the various aspects of the pyramid. Like a pyramid, you need a strong base or the entire structure will collapse!
Depending on which version you look at, they either explicitly or implicitly have your GOAL as the base.
Your Goal
While it is possible to take an action repeatedly, it is easier to do so when you have a goal that the action supports.
An example would be saving and moderating spending. It’s easy to say it’s only $5 a day for that scone and coffee shop coffee each morning on the way to work. Not a big deal.
Now, if you consider that $5/day times the 200 work days a year becomes $1000, then it isn’t such a small deal. What can you do with $1000? A trip? Winter tires? New computer? Life insurance for the family?
So the first step is to understand what you want to accomplish both short term and long term.
Cash Flow
As part of this you need to look at your budget. This means accounting for all Income and Expenses. Do you know where you spend ALL of your money? If you pay cash, do you get receipts? Do you track your cash flow?
I helped a client a few years ago who came to me because she had no idea where her money was going. All she knew is that she had a pretty good salary and her savings were not increasing. I had her track every cent in and out for 3 months. She made sure to get receipts for all purchases. She then put all these expenses into a spreadsheet, and categorized each item. She also noted if it was a regular expense or a one-off.
Once she saw how semi-regular expenses (it’s only a coffee) was eating up her income, she decided to change her spending. All of a sudden (in month 2) her savings account started to go up.
Security
Having a goal is awesome. Lets imagine you’ve set your goals and have been saving towards them for a number of years. And then something bad happens (illness/job layoff/car engine dies/…). Will your goal still be attainable?
First step to protecting your long term goals is financial security.
- Start with an emergency fund.
- Include insurance(s) against those catastrophic events.
- Eliminate liabilities (debt) where possible
- Manage cash flow
Some items are self evident. If you own a car, you are required to have car insurance. If you own a house, your mortgage company will require you to have home insurance.
But what about your life, health and well being?
- Disability Insurance to protect you for loss of income due to injury
- Critical Illness Insurance to protect you against disease
- Life Insurance to protect your family against loss of your income due to death.
- Health and Dental insurance (Extended Health Care) to protect against out of pocket expenses for illness.
Save for the Future
Once you have a surplus of income, it is time to start looking towards the future.
- Children’s College Fund
- Retirement
- Once in a lifetime trip
At this stage, you need an investment vehicle more complex than the savings account at your local bank. The right vessel depends on what your goal is and how soon you want that goal to occur.
You should also start to consider tax efficiency at this stage. Tied into this should be some thought to estate planning.
Investments
After a certain point, your savings are covering your short and medium term goals, and we can now look at wealth accumulation. Here we take a look at bigger risk/bigger reward investments.
At this stage tax efficiency will be very important, as will estate planning.
Financial Freedom (Independence)
At this stage, all of your monthly expenses can be covered from your monthly income from Investments. This means you no longer need a job!
Estate planning should have been taken care of well before now, but if it hasn’t get it done!
Utilization
At this stage you have more than enough income to cover expenses. This is when you retire early, and start to enjoy your freedom.
Your life’s Passion is one area to utilize your wealth.
How about Legacy? Are you setting your kids up so they don’t have to work?
How about Charities?