In the previous blog post, we delved into the Hierarchy of Financial Needs, drawing parallels to Maslow’s hierarchy to illustrate how our financial priorities evolve when we're at different stages.
There might still seem to be some gaps between the idea of Hierarchy of Financial Needs and real-life applications. Don't worry, here are practical steps to help you decide where your next dollar should go, leveraging insights from the provided guide. As always, this is intended to be educational and should not be construed as financial advice.
We'll use the checklist below as a visual guide. You can click on the image to download the pdf.
Step 1: Assess Your Financial Security
Before making any financial moves, ensure your foundation is solid. Ask yourself:
Do I have an adequate emergency fund?
Am I free from high-interest debt?
Do I have sufficient insurance coverage?
Am I financially solvent?
If the answer is no to any of these, your next dollar should address these foundational needs. In the Hierarchy of Financial Needs, this essentially translates to the layer "Financial Security" and below. If that describes you, then bolstering your emergency fund, paying off high-interest debt, or increasing your insurance coverage to build a robust financial base would be the most appropriate action for your next dollar.
Step 2: Maximize Employer Benefits
Once you have any excess cash beyond the emergency fund, it'll be a good time to consider if you have taken advantage of all the "free money" available through employer benefits.
Matching Contributions: Ensure you're contributing enough to receive any available matching contributions from your employer.
Employee Stock Purchase Plans (ESPP): If offered, consider participating to leverage potential stock purchase discounts.
Step 3: Define Your Financial Goals
If you have sufficiently taken advantage of the "free money" offered. It's time to consider what the primary goal for the next dollar is. Your goals will dictate the best strategy for allocation. Common goals include:
Saving for Retirement: Consider contributing to retirement accounts like an IRA or 401(k). This is generally for people in the "Build Wealth" layer of financial needs hierachcy.
Specific Expenses or Goals: Save for education, medical expenses, charity, weddings, homes, vehicles, vacations, or rental property purchases. Since retirement is a specific instance for goals, this is also suitable for people in the "Build Wealth" layer of the hierarchy.
Broader Financial Planning Objectives: Engage in strategic tax planning, estate/legacy planning, etc. The document stated paying off debts as one of the objectives but I interpret that more so as a relatively low-interest loan such as your mortgage. If you have high-interest loans such as credit card loans or payday loans, we should go back to step one. This is suitable for people in the "Build Wealth" layer in the hierarchy and above.
Other Considerations:
The steps above might seem straightforward enough. After we identify what we want to do with our next dollar, we still need to figure out where we want this dollar to go.
Here are three considerations that can help you decide on the specific account types and general investment philosophies for these accounts.
1. Consider Tax Flexibility (Pre-tax? After-tax? Taxable?)
Evaluate whether you prefer tax flexibility in the future, even if it means paying taxes now. If yes, contributions to Roth (after-tax) retirement accounts can be advantageous, offering tax-insensitive withdrawals later. If not, utilizing pre-tax accounts is a great way to defer your tax liability to the future.
2: Assess Withdrawal Needs (Account Types)
Are you able to save in a retirement account, and are you comfortable with potentially limited flexibility with pre-retirement withdrawals? If short-term access to funds is a concern, non-retirement savings options might be more suitable. A common but powerful non-retirement savings account is the brokerage account, and why yes, I do have an article on that:
For example, if you have identified that you want to fund a trip for your 10th wedding anniversary in 2 years, then a retirement account would generally not be a good place to save for your trip since the rules and regulations for retirement accounts (401(k), IRA, SEP, etc) are designed to encourage long-term savings.
3: Plan for Short-Term vs. Long-Term Needs (Investment Strategies)
When we think about the specific investments, I would encourage you to think about the time horizon and risks first.
Determine if you need the money in the short term (e.g., within five years). For short-term needs, prioritize liquid and low-volatility assets like bonds, bond funds, CDs, MYGAs, money markets, and cash. In our previous example, your trip is coming up in 2 years so we have a limited time for the money to grow and we want to ensure the safety of your funds so you don't sacrifice the quality of your trip. So generally the best place to save for your trip would be a High Yield Savings Account.
For long-term growth, consider investing in higher-yield assets like equities, real estate, or high-yield bonds, balancing growth potential with risk tolerance and liquidity needs.
Parting Notes
To stay motivated and on track, visualize your progress through the hierarchy. And don't forget to celebrate victories big and small!
Every financial journey is unique, and sometimes you need a little extra help to navigate the path. As a fee-only financial planner specializing in helping mid-career families, I'm here to provide personalized advice and support tailored to your specific needs and goals. Please don't hesitate to reach out!
Happy (financial) trekking!
Disclosure:
All written content on this site is for informational purposes only.Opinions expresses herein are solely those of Savor Financial, a Core Planning brand.All information and ideas should be discussed in detail with your individual advisor prior to implementation. Investment advisory services are offered through Core Planning, LLC.The presence of this website on the internet shall in no direct or indirect way be construed or interpreted as a solicitation to sell or offer to sell investment advisory services.The information contained here is general in nature and is not intended as legal, tax, or investment advice. Further, the information contained herein may not be applicable to, or suitable for, the individuals’ specific circumstances or needs and may require consideration of other matters.CP does not provide legal advice or drafting services. Estate planning is considered incidental within the context of a financial plan. We will coordinate with your family attorney of choice. CP is not a certified public accountant and does not provide tax filing services. Tax related advising is considered incidental within the context of a financial plan. We will coordinate with your CPA of choice.
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