Hierarchy of a Strong Financial Foundation
There is a proper hierarchy to personal finance.
In 2015, I was invited by a friend to attend a financial literacy seminar in Makati. During that time, I was just starting in the corporate world and still learning many things - personal finance was one of the topics that caught my attention.
That seminar was an eye-opener for me. I realized that having a stable job is not enough, and working for the next forty-or-so years is not the route for me if I am to live a more meaningful life.
We need to strengthen our financial foundation to handle our money properly and transform it to help us build a better future.
Building a Strong Financial Foundation
I remembered the parable of the wise and foolish builders. One man built his house on the sand, while the other built his house on a rock. So when the rain, flood, and wind came, the house built on a stronger foundation remained. (Matthew 7:24–27)
Like in construction, we must create a strong foundation for our finance. This diagram shows the basic money management hierarchy that can guide us on which steps to take before finally investing.
Like Maslow's Hierarchy of Needs, personal finance should follow a step-by-step process.
1. Manage Your Cash Flow
The first step to a strong financial foundation is managing your cash flow. A cash flow is how much money is left to you after you deduct your expenses from your income after every pay period.
You can think of cash flow as the simple formula below:
Cash Flow = Income - Expenses
Your cash flow can be positive or negative, depending on how big your expenses are relative to your income. So, to ensure a positive cash flow, we need to have a higher income than our expenses.
A common mistake for beginners in their financial journey is they often go straight to investing without taking a hard look at their cash flow.
We need to understand that it would be much more difficult to manage money if we don’t have the money to manage. How can we proceed to budgeting if we don’t have any income in the first place?
This is why we must ensure a positive cash flow when building strong finance by either increasing our income or decreasing expenses — or both.
2. Invest in Your Healthcare
The next block for strong personal finance is ourselves. We may earn a high salary, but things will be difficult if our health fails us and forces us to stop working without healthcare insurance.
HMOs are usually provided for private company employees and can cover many health-related expenses but only for a short time or until you stop working. That is why we also need long-term healthcare in case we live longer.
Depending on your lifestyle and hereditary illnesses, your healthcare coverage should also be personalized for your needs.
3. Transfer Risk Through Insurance
Life Insurance may be more popular now, but it is more important than most think. Insurance is more than just buying something that you may not use. Essentially, purchasing insurance is a transfer of risk.
You are transferring risk away from yourself and to the insurance company. It is like buying peace of mind that your family would not be financially burdened if anything happens to you.
In case of untimely demise, the financial burden should not be added to the emotional stress that they will go through.
The most important insurance.
If life insurance is often neglected, there is one other insurance that holds eternal value. That is soul insurance. If ever we're to use our life insurance and meet our Maker, I hope you'll also have the assurance of salvation through faith in the Lord Jesus Christ.
There is peace and assurance that only God can give.
For God so loved the world that He gave His only begotten Son, that whoever believes in Him should not perish but have everlasting life.
John 3:16 (NKJV)
6 Be anxious for nothing, but in everything by prayer and supplication, with thanksgiving, let your requests be made known to God; 7 and the peace of God, which surpasses all understanding, will guard your hearts and minds through Christ Jesus.
Philippians 4:6-7 (NKJV)
4. Keep Your Debt at a Manageable Level
The next step for a strong financial foundation is to control your debt, but it will be better if you don’t have debt at all.
Usually, there are good debt and bad debt, where good debt has potential returns, like a business loan, while bad debts have little to no returns, such as online shopping and credit card debts.
It would be better for most to avoid any debt as much as possible, unless you’re already in your expansion phase, to avoid getting into the debt trap and any potential of bankruptcy.
Debt culture is a deeply embedded approach for many that can crumple a relatively good financial foundation.
5. Save For Your Emergency Fund
An emergency fund is your financial safety net if unexpected things happen caused by unforeseen events that can derail your finances, like losing a job, an immediate house repair, or getting sick.
As a rule of thumb, an emergency fund is three to six months' worth of your income, but you can always increase it to up to a year’s worth, depending on your current financial status.
6. Start Investing
Lastly, only after you have completed working on the higher-priority levels, such as managing your cash flow, investing in your health and life insurance, managing your debt, and saving for an emergency fund, will you start to invest.
There are many investments to choose from, like real estate, mutual funds, the stock market, FOREX, cryptocurrency, your own business, and many more.
When we don't trust the process of building a strong financial foundation and go directly to investing, one major emergency can wipe out all our hard-earned investments.
In Summary:
Manage Your Cash Flow. Ensure that your income is higher than your expenses.
Invest in Your Healthcare. Have a safety net for when you get sick.
Transfer Risk Through Insurance. Your insurance will cover your family’s expenses if something happens to you.
Keep Your Debt at a Manageable Level. Avoid debt if you can, or at least a level that will not bankrupt you.
Save For Your Emergency Fund—three to six months’ worth of salary.
Start Investing. Invest for the long-term.