From Survival Mode to Financial Independence: Where Do You Stand?

It has been twelve years since I took a psychology class as a high school senior, but I remember a few things from Mr. Erwin’s class.  First, Mr. Erwin rode his bike to school every single day.  Second, we watched the Shawshank Redemption in class, and it was awesome.  Third, Pavlov had a dog.  Lastly, was Maslow’s Hierarchy of Needs.

Maslow’s hierarchy was a theory that essentially said people have different levels of needs, and in order to achieve the higher levels, one must first achieve the lowest or most basic levels.  Can’t the same thing be said about personal finance?  It is hard to justify buying a Lamborghini if I haven’t been able to afford a trip to the grocery store.  In my Hierarchy of Personal Finance, there are five levels of achievement, and just like is Maslow’s hierarchy, one must obtain the basic levels first, before reaching the highest levels.  Here is my hierarchy from lowest to highest:

Survival

At the most basic level of personal finance, we are talking about just getting by.  One has reached the survival level once you are able to meet your basic needs of food, water, and shelter.  For many of us, this level conjures up images of our very first night in our own apartment.  We had somehow managed to save up enough money for the apartment deposit and our paycheck was enough for rent and food, but somehow forgot we might need to have seating for guests.

The Survival Level is reserved for items which cannot be eliminated from our budgets without some dire consequences.  Although many people turn towards eating out less when creating a budget, no one eliminates food altogether.  An often overlooked portion of the Survival Level is taxes.  If you are earning a paycheck, chances are you are paying taxes, and if you are buying something, chances are you are paying taxes on it.  Although you do not need to pay taxes to survive, avoiding them can certainly derail your ability to achieve any of the higher levels.

Safety/Security/Fear

Level two is all about removing risk, minimizing fears, and establishing safety.  For most people, level one is fairly easy to obtain.  Level two is usually where problems start to arise since it is all about preparing for the unexpected.  For most of us that means obtaining insurance.  Insurance helps to minimize fears for people — without health insurance, a person may fear getting sick; without auto insurance, a person may fear getting in an accident.  Sure people still fear those things, but with insurance the fear is less than that of an uninsured person.

It is at this level that people need to establish a safe environment as well, which may mean moving from the shelter established in level one.  If your food or shelter is compromised in some way and you are unable to establish safety, then it is hard to move to higher personal finance level such as savings.  One of the more difficult things to accomplish in this level is establishing an emergency fund.  If level one is consuming all your resources, when the inevitable emergency comes, you may find yourself resorting to taking on debt to establish safety and security.

Debt Reduction/Increase Income

Level three can be one of the most difficult stages in the Personal Finance Hierarchy.  This level is about reducing debt and increasing your means.  Many of us will take on debt in our lives, but the type of debt you take on may determine whether or not you move onto level four.

One example of “good debt” is debt that helps you achieve a level two, or debt that increases your human capital.  For me I took on debt for my house which helped me achieve shelter (level 1) and achieve a safe environment to minimize my fears of my family being harmed (level 2).  Other people take on student loan debt to help improve their marketability to increase their income.

“Bad debt” includes revolving debt like that found in credit cards.  In some cases credit cards could help you achieve levels 1 and 2, but often times credit cards debt reflects an imbalance between income and wants vs. needs.  This potential imbalance is an ongoing thing — so a person could find themselves in a situation where they have moved on to level four by reducing debt and increasing income, but later find they over extended themselves and used too much “bad debt” on fulfilling wants rather than needs.  Others may find that they are never fully able to move passed level three.  Fulfillment of level three is usually a combination of decreasing debt and increasing human capital (increasing income).

Savings/Accumulation

Levels three and four are fluid in the sense that in many cases they are usually occurring at the same time.  We may be reducing our debt and increasing our income at the same time we are meeting savings goals and accumulating our wants.  Generally, the faster level three is obtained (reducing debt/increasing income), the faster savings and other goals can be met.

One of the more common excuses I hear from people as to why they don’t save for retirement is that they can’t afford too.  This is exactly what our hierarchy tells us.  If someone is overburdened by levels one through three, how can they save for the future?  Significant savings for retirement, vacations, and college can only be accomplished once fears of financial ruin can be squashed through attainment, or progress toward the first three levels.  The accumulation of wants in this level can also lead to someone falling back into a level three because they have taken on too much debt.  The wants you obtain should be limited by your debt and income.  It would be silly to buy a Lamborghini if the purchase price was seven times your annual salary.

Again the greater emphasis here is on balance among income, and wants vs. needs.  For me, I know I have been able to save for retirement throughout my working career, but I also significantly increased my savings as income rose and my debt decreased.

Financial Independence

The final level of Financial Independence may mean something different for each person, and much like some of the previous levels, there is some fluidity or blending of levels here. This level begs the question, how well are you able to sleep at night considering your money issues?  Another way to look at it is, are you able to accomplish your money goals?

For me, Financial Independence is retirement or, maybe more accurately, the ability to live from my own means without the influence of an outside source (needing to work for a living).  For other people this level may simply mean you are able to afford that vacation you have been saving for.  For others it may mean they can afford to weather an emergency (level 2).  The idea of financial independence is about removing the burden that money issues can sometimes place on our lives.

Where do you feel like you currently stand in this hierarchy? 

===================================================

This post was written by Chris Kamp, a Field Education Representative from Colorado PERA, on March 11, 2015 (Wednesday). Original article can be seen here. 

Life After 25: What Financial Plans Should You Make

If you are looking at the prospect of a quarter of your life having already passed you by, you are probably starting to think about your future, because there is no denying it anymore – you’re a grown up.

At 25 you are also in the enviable position of still having most of your working life ahead of you, so you have ample opportunity to save, invest, plan and prosper. In your teens and early 20’s you probably made the most of life and enjoyed the independence and freedom which came with earning your own income.

However, once you pass over the threshold of 25 it is time to also take on the responsibility which comes with that financial freedom and implement responsible spending and savings habits, including a budget, an investment plan, a plan to pay off any debt and make sure that you can maintain that financial freedom.

To start your financial plans once you reach 25 years old, look at your short, medium and long term goals:

1. Short term goals are around five years away and can include a wedding and honeymoon, a new car or new furniture.

2. Medium term goals are things like owning your own home and paying for your children’s education.

3. Your long term goals are what you want to get out retirement, whether it is travel, a big home, a big boat or a summer house in France.

Now make some estimations of how much you will need to meet each of your goals, and then work out how much you will need to save each month to meet those goals on schedule. You can use a calculator, spreadsheet or online tool or app to help you.

While it may be hard to imagine planning for your retirement when it is at least 40 years away, you have some unique opportunities and unique benefits if you start saving now. For example, workers in their 20s have an overall diminished loyalty to employers and with so many more job changes, you can be looking at a smaller retirement fund contribution and other benefits such as long service leave.

Plus, it is looking less and less likely that retirement benefits will be around in 40 years, and while retirees have trouble living on a pension now, the benefits will be even slimmer in the future.

How to Meet Your Goals

Luckily you have tonnes of time on your side to carve out the life and financial future you want for yourself and your family. Creating a budget and putting away money in your savings for your short, medium and long term goals is a good way to plan for your future.

Just make sure that you have set a budget you can stick to, where you don’t miss out on too many luxuries or entertainment, because falling off the budget wagon can cost you in splurged savings and credit card repayments.

You also need to start looking at what else you can do with your money to make it work harder for you. You may want to start by looking at term deposits, or certificates of deposit where you can invest a certain amount of your savings at a fixed interest rate for a guaranteed return over a set term. Just remember that you won’t be able to access those funds during that term, which could be just the incentive you need to force you to continue saving.

Stock market investments typically outperform every other form of investment in the long term, but you will need to dedicate more time to managing and monitoring your investments, and be prepared for seemingly significant ups and downs along the way.

You can also invest in a dedicated retirement savings account which may be provided by your employer, and which you can make additional contributions. Retirement savings accounts external to your employer can also earn you a high interest rate, and in some cases you can be eligible for government contributions which will match your own deposits up to a capped amount each year.

Financial Plans at 25

While there are still a lot of financial variables between being 25 years old and hitting retirement age, the financial plans you make now can help set you on the right track. At 25 your biggest asset is your ability to earn an income and if you become sick or injured then your income will be affected and so will all of the savings and investment plans you have so carefully put in place.

Therefore, start comparing life insurance and income protection insurance policies which will pay a benefit to your family if you die, and can also continue to pay out a large portion of your income if you become sick or injured and cannot work for an extended period of time. You may also want to consider permanent disability insurance in case you need specialist care and you are unable to return to full time work.

Your first home will also be a big part of your financial plan if you are 25 years old and making the right decisions regarding buying and paying off your home are an important part of your financial plan.

Before you start looking for your first home and you fall in love with a property you can’t afford, speak to a bank or mortgage broker to find out exactly how much you can afford to borrow – not how much you are eligible to borrow, but how much you can afford to borrow while still maintaining your lifestyle and your savings and investment plans, and accounting for any emergencies.

That’s right, even while you are repaying a mortgage on your home you should continue to maintain your savings and investment plans. For a successful financial future and a fruitful retirement you need two things – to own your own home so you’re not paying a mortgage on your pension, and to have a passive income stream from your investment so you don’t have to rely on the pension and have enough funds to fulfill your dreams.

Therefore, you need to take a holistic view of your finances, rather than focusing on just repaying your mortgage and then finding you only have ten years to prepare for your retirement.

Your investments especially can make your money work harder for you as you work hard to build the life you want, because the expenses involved in your investments are tax deductible. For example, the interest and on an investment loan if you buy a property to rent out, or the interest and fees on a margin loan if you borrow to invest in the stock market.

===========================================

This post was written by Alban on September 8, 2014 (Monday).  Original article can be seen here.