Pyramids (Photo credit: Mathew Knott)
One of the basic fundamentals regarding financial planning and saving money revolves around what is known as the financial planning pyramid. You may hear other names such as the wealth management pyramid, the financial house, etc. You may also see different stages or “building blocks” added here or there, but I’ve broken it down for the purpose of this book to three basic levels for easier understanding.
The first level is where we see risk management. This is the foundation of your plan. It’s important to have a strong base to build off of, otherwise the slightest of breezes or tremors can send it toppling. Risk management can be simply seen as your insurance – and this can range from your auto, home, renters, life, health, disability, and umbrella insurance, to your will, emergency fund, and debt management.
The reason why insurance is the base is due to the fact that we have risks that most of us cannot afford to take on ourselves. Most of us don’t have $300,000 stored away to rebuild our home if it’s destroyed and most of us don’t have a million dollars to pay in case were liable for damages in an auto accident. By using proper risk management and having the correct insurance in place, we can leverage that risk and only pay a small amount of premium for a large amount of coverage.
The proper insurance coverage will make sure in the event of the worst happening, you have a bad day, not a bad life. Proper coverage can protect our wealth and our savings. Likewise with an emergency fund and a will. An emergency fund is just that – 3 to 6 months of living expenses in case you lose your job, become ill or suffer a loss and have high insurance deductibles. A will protects you making sure if and when you die, your possessions go to the people you want them to, and assign guardians for your children.
The next level is the wealth accumulation level. This is where we start saving via IRAs, 401(k)s, and other savings vehicles. It may also be the area where you may invest in not only the stock market, but also real estate, and other investments you know. Notice that it builds off of the risk management foundation – just in case you’re sued or suffer a catastrophic loss, your wealth is secure, since you have a solid base.
Finally, you have the estate planning level making the pyramid complete. This is where distributions strategies are employed regarding the wealth you’ve built, where proper trusts and other legal entities are employed to protect wealth from taxation. It’s also the level where people think about charitable giving and leaving a legacy.
It goes without saying; please see a competent professional when working and employing strategies in any of the levels of the pyramid.