How I Manage My Money
Frequently, there are articles on the internet that explain where and how you should manage your money. Less often you find articles from financial advisors telling you what they personally do. You may wonder if they ever listen to their own advice. The following article supports my philosophy on how to manage personal finance.
The reason for using a pyramid is because it represents a strong structure. For example, the pyramids at Giza have been standing for 4,500 years. If we apply this structure to our finances it can better prepare us to withstand the test of time. In the financial pyramid, we split it into 4 sections starting from the bottom and working up.
At the foundation of everyone’s financial pyramid is “Asset Protection.” Our assets include things like our cars and homes. The protection part of that is setting up a plan that allows us to be prepared for the unknown. If we don’t know when a fire could strike our home or when a car accident might happen, how do we plan for that? This is done simply by buying insurance for these assets. This isn’t the fun part of finance but it’s extremely important. Just like the foundation of a home, everything else is built upon it.
Savings vs. Debt
The focus of this section is liquidity and minimizing how much we are paying in interest. The savings is our emergency fund. The recommendation here is to save 3-6 months' worth of our expenses. When determining if paying down debt or building an emergency fund comes first, a good rule of thumb is with good debt (debt that helps build credit), focus on building an emergency fund, with bad debt, focus on paying that down. For example, if the debt you have is from a credit card that has high-interest rates, it is probably best to put your focus there. Check out my article How to Build an Emergency Fund for some simple tips to get started.
Real Estate/ Short-Term Investments
With a solid debt and/or short-term savings plan, it’s now ok to look at goals that are 5-15 years down the road. Since we don’t need this money immediately, we can begin using investment vehicles that will potentially earn a little more interest. Some of these goals could be: children’s education funds/marriage funds, purchasing a home, finishing the basement, or anything that is a few years down the road. Another name for short-term investments is intermediate savings, these investments are usually not meant to be risky. There are a lot of tools available because the key is trying to get a better return than the typical 0.01% that checking/savings accounts give. The tool you use depends heavily on the time frame and the purpose for the money, and if you have questions on what options are available, consulting a financial professional would be worth your time.
The mindset here is maximum growth over the long term. We can feel confident about that because we have time on our side. We can weather the ups and downs of the market and still come out ahead. The most commonly used long-term investment tools are companies 401(k)’s, Roth IRA’s, and Traditional IRA’s. This is because of the tax advantages and the company matches.
A Few Key Concepts to Remember
To be financially stable, a solid base is needed.
We don’t know when things will happen but we know they will. By building from the bottom up we can be ready for things we can’t plan for.
By allocating our money in these 4 sections our accounts have a multiplier effect. This is because we don’t need to pull from our retirement investments to fund an emergency.
Letting the time frame dictate the financial tool.
The different sections can be addressed at the same time. It is not required to check one off before moving on.