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Hierarchy of Financial Needs



Summary

 

Introduction

As the saying goes, one needs money (finances) to run a happy life. But why do we need money? What do we do with them?  Here are the typical large financial goals that most of us aim to attain (in no particular sequence).

  • Pay off debt (credit cards, student loans, auto loans, mortgage, etc.);
  • Build an emergency fund;
  • Ensure that our children are able to attend school without being burdened by student loan debt;
  • Buy a home;
  • Business planning;
  • Save and invest for retirement.

It's a certainty that you won't be able to fund all of your financial goals at once, no matter what they are. Prioritization is the name of the game.

Prioritization Pyramid

In the previous two articles of our savings campaign, we discussed short-term savings and building an emergency fund. These short-term savings fulfill some financial needs.

Maslow's Hierarchy of Needs is a well-known model that is structured like a pyramid. It basically says that “Before individuals can attend to wants higher up in the hierarchy, lower-level demands must be met.

The same can be applied to Personal Finance as well. When deciding how to spend money, one must prioritize their necessities first, then their wants. Only after all of the needs have been met a person should consider his/her wants. That is, in order for individuals to achieve the highest financial goal, It is inevitable that our basic financial needs have to be satisfied and be well-taken care of so that we may move up the stages with confidence. We will explore how Maslow’s theory applies to our financial needs, pinning down the steps to creating a strong financial foundation.

 

 

Stage 1: Financial Survival

Your first priority should be to ensure your survival now and tomorrow. Our most basic need is to survive. If we don’t, then nothing else matters. Receiving money to spend on your fundamental necessities for survival is the first step toward financial survival. Food, shelter, and clothes are among these necessities. You'll need a source of money to maintain yourself. To satisfy their fundamental survival needs and living expenditures, the majority of people begin by finding a job. Some people are driven into debt because they do not earn enough money to satisfy their requirements.

You will automatically move to the next stage after your financial survival demands have been satisfied.

 

Stage 2: Financial Stability

Stability is the second step in the Hierarchy of Financial Needs. This step is required to guarantee that you do not revert to financial survival mode. One must plan for instances when things do not go as planned. Workers who lost income due to the epidemic had to go into savings, go into debt, or enroll in hardship programs in order to pay their obligations during the last year. This period has served as a harsh reminder of the value of maintaining an emergency fund. When your most basic requirements are fulfilled, you may begin to think about risk. The most important method to prevent going backwards is to preserve. Begin with an emergency fund. Set aside at least four months' worth of living costs in a high-interest-earning account. In times of financial instability, expand it to 6 months. The emergency fund is so you don’t lose your ability to cover the first tier if something goes badly wrong.

Financial stability is defined by a consistent income, adhering to a budget, and meeting monthly commitments on schedule. All of these enable you to create an emergency fund and begin saving for the future!

 

Stage 3: Wealth Accumulation

When you have achieved financial stability, you can begin to concentrate on the accumulation phase. This is the stage in which the majority of people spend the majority of their lives. This includes growing investments, paying down debt, and saving for retirement. At this level, the focus shifts to growing assets for long-term success and longevity. Concentrate on increasing your income, maximizing your savings, and spending intentionally on the things that are most important to you. Long-term care and children’s education can also be found within this category, along with retirement savings and vacations. These financial needs are linked with esteem needs, such as self-respect and personal accomplishment.

As your savings grows, you will want to invest in riskier assets to build your wealth. Otherwise, inflation will erode the value of your money.

 

Stage 4: Financial Independence

You made it! It was a long road and you finally reached your goal. Over the previous 3 stages, you have built positive financial habits. Now, it’s time to reap your rewards!. When you reach the Financial Independence stage, celebrate! Take your time. Go do the things you have always wanted and dreamed of doing!

Financial independence means you are able to live on income from pensions, investments or passive income such as dividends, royalties and rental income. It often refers to the retirement years, but it can also mean the freedom to work how, when and where you like. It means not having to worry about money.

 

Stage 5: Legacy

The top step on the Hierarchy of Financial Needs is your legacy. You have spent decades to get to the point where you are today, financially secure and independent. Now, with all of the assets you’ll ever need, turn your focus to what really matters to you. Estate planning, tax planning, and business succession planning all fall within this category, connecting with self-actualization in Maslow’s pyramid.  Also, you leave a legacy by making a difference in someone else’s life. Make charitable donations to a cause you believe in. Help your children or grandchildren with their education expenses or start a business

Naturally, financial needs can shift based on a given situation. But as a general rule of thumb, moving along this path can help create an enduring roadmap for financial health.

 

Want to move to the next level?

So, now that we have seen the various stages of Financial Needs. At which stage are you in? Our guess is that, as you are reading this, you will be at Stage 3 or higher. As we mentioned above, as your savings grow, you will want to diversify your investments into riskier assets in order to increase your wealth. As your wealth grows, you may want to consider more advanced techniques. It may make sense to take on additional risks depending on your age and risk tolerance.

 

 

Can Crypto be part of your financial plans?

Crypto-assets are real, here to stay they deserve the location of your financial plan. Crypto-assets are now more secure and accessible than ever before. Some experts believe crypto-assets – and the computer networks they represent – will usher in another digital upheaval of the economy, displacing our current banking and payment systems. This conviction, along with a healthy dose of investor speculation, is propelling the market capitalization of all cryptography-derived currencies. It is past time to consider them as an asset class. For more detailed information, read our dedicated article.

Which Asset Category does crypto fall into?

Financial wealth is represented by the assets you own. This can be your house, a business, retirement savings …. Each asset has intrinsic value, and each counts towards your net worth. But not all assets are equal, which is why you need to categorize them. In doing so, you will be able to objectively manage the risk and return on each asset category.

A well-structured financial plan generally allocates wealth into four broad asset categories, the total of which represents your net worth.

1. Business asset? 

Do you mine Bitcoin? Is this a business that you actively manage and that generates revenue? This might be true for a very tiny percentage of the population. If your crypto investment falls into this category, you should have a business strategy in place for capital investment, operations, and forecasted returns, as well as how you plan to handle risks like fraud and company continuity.

 

2. Lifestyle asset? 

Many individuals are interested in cryptocurrency trading; these are the ones that prefer to debate Ripple versus Ethereum over a braai. If you consider your cryptocurrency investment to be a status symbol, it should be classified as a lifestyle asset, similar to a car, rather than something you rely on to produce income or contribute to your retirement plan. If this is the situation for you, make sure you set a sensible investment limit.

 

3. Lifetime asset?

One must account for price volatility and the unpredictability of crypto asset value. Remember that your lifetime assets are your safety net - a pool of funds from which you may draw when you no longer generate an income. Lifetime assets should thus be considered a safe option, a get-rich-slowly asset that is predictable and will not surprise you.

 

4. Legacy asset?

If your bitcoin investment does not go into one of the previous three categories, it will most likely fall into this one. The legacy asset class is a catch-all asset class: assets that you are not relying on to support your lifestyle or retirement; something to have some fun with. If you're lucky, you'll leave anything for your beneficiaries; if not, that's OK, too. The majority of cryptocurrency investors fall into this category.

It’s usually quite easy to decide which category an asset falls into. Take your primary residence, for example. It certainly has value, and it may well appreciate over time, but it’s more important as a place of safety and security for you and your family, which is why it’s classified as a lifestyle asset.

But it’s not so simple when it comes to crypto assets – the new kid on the block. You could call crypto an “investment” and leave it at that, but that would be a cop-out. Remember, all wealth needs to be categorized to have meaning and purpose. 

 

Controlled risk is the way to go

And before you take that cherry out of the jar, you'll need to put the remainder of your dessert together. In non-ice cream words, this means establishing a solid financial foundation and learning everything you can about cryptocurrency before investing real money.

As with any new investment, it is critical to conduct thorough research and understand all of the risks. Experts advise against investing in cryptocurrency if it means you won't be able to meet other financial obligations, such as paying off debt or creating an emergency fund. With the rise of cryptocurrency dominating the news, it's tough to remain on the sidelines and not be a part of the activity. You don't have to either, as long as you understand how your crypto investment fits into your overall wealth-building strategy.

In the long term, crypto-assets could be a critical component of every balanced portfolio, but we aren't there yet. If you do have some spare cash lying around and crypto is your legacy asset, then give it a try. The more you know about the asset class of the future, the better. Do you want to catch in before everyone does? Think about it. We will meet you in the next article of our savings campaign!


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