Financial Planning Pyramid: Foundations
You can’t build a house from the top down, right? Like most solid structures, they start with solid base, a firm foundation. Some of the biggest skyscrapers are started below ground level, well beyond what’s in our view when we look at the behemoths of structures. Can you imagine a skyscraper built on just a foundation of concrete? The first strong wind or tremor would send it toppling. The same process can be applied to financial planning. You have to have a solid base, a firm foundation before you can think about building a portfolio, estate planning, etc.
Generally, the financial planning pyramid starts with the base known as risk management. This includes such risks as auto and home insurance, an emergency fund, life and disability insurance, and a will. Having this solid base protects you from many risks in life, but also protects your plan and your money that you’ve worked so hard to earn and invest. For example, let’s say you’re at fault in an auto accident and are liable for $500,000 in damages. Proper auto insurance liability limits will take care of this amount. If you don’t carry enough coverage or choose to not have insurance, then you are essentially choosing to self-insure – meaning you’ll pay the damages out of pocket. Very few people I know can afford to do this; which is why we transfer that risk to the auto insurance company. This scenario can be made analogous to home insurance, pre-mature death (life insurance), an emergency fund (unexpected expenses from job loss or to pay high deductibles in an insurance policy), and so on. It’s this risk management base that protects our wealth and future wealth and plans, so we don’t have to dip into our IRA, 401(k), etc., and having our financial future being upended.
Another time, I’ll dive into and explore the middle of the pyramid – wealth accumulation and management.