Why Every Millennial Needs a Personal Finance Pyramid

We see personal finance in three tiers – a personal finance pyramid.

Often, when people start to learn about building wealth, they either don’t know where to start or focus on only one area.

Often when I tell people my profession, they ask me to recommend stocks or investments.

And, while choosing the right investments is an important aspect of your personal finances, you must first know your current financial situation and your financial goals.

That’s how you’ll create your very own personal finance pyramid, which will guide your future financial success.

Current Finances and Goals

The base of the pyramid is your current finances and financial goals.

Without this information, it is difficult to make well-informed decisions about the next two levels.

First, you must examine your current financial health, which includes determining your annual net income and your assets and liabilities.

In knowing your current situation you are able to determine your goals and how you are going to accomplish them.

Goals can be both short and long-term – such as saving for an upcoming vacation or building enough capital to live job-free off of investments.

Here is an example of our short and long-term goals:

• Pay off student loan debt within next 3 years
• Max out our Roth IRA contributions ($11,000)
• Purchase single-family income properties
• Build enough capital to generate $75,000 annually from investments

You should have similar goals set for yourself that are relatively short-term and then long-term looking at your retirement years.

Figure Out Your Strategy

After you have an understanding of where you are and where you want to go financially, you can determine the strategies and investment vehicles that will get you there.

You have many different types of investment vehicles that you can use to accumulate and build wealth.

Two of the best known are 401(k) and IRA accounts, which offer tax advantages.

In addition, there are other vehicles such as an HSA (Health Savings Account) accounts or a variable annuity which we will get into in another post.

Even choosing a money market account, savings account, or different account for your cash balances can be a strategy depending on your specific situation.

Here are the investment vehicles we currently use:

• 401(K): Employer matches the personal pre-tax contribution up to a percentage of total salary — allows the funds to grow tax-deferred
• Roth IRAs: Contributions are after-tax but withdrawals after age 59.5 are tax-free
• Health Savings Account: Pre-tax contributions are not taxed when withdrawn if used for medical expenses

Each investment vehicle has a slightly different advantage to help you accomplish your goals.

You can balance your short and long-term goals by strategizing and selecting specific investment vehicles.

Here are our strategies:

• Reduce expenses to essentials and occasional entertainment to pay off student loan debt and max out IRA contributions
• Use 401(K) match to increase pre-tax savings for income after 59.5
• Reduce debt to increase lending limits for investment properties

Build Your Investments

The top of pyramid consists of the investments that you choose with your capital.

Generally, your investments are either growing, generating income, or both.

Here some examples:

Growing investment: Small and New Companies

• You may invest in a new or young company with the expectation that the company will reinvest its earning and continue building the company. As the company grows and generates more income, your share of the company is worth more.

Income generating investment: Bonds

• You could invest in a bond with the expectation that you will lend out your capital and receive interest payments.

Growing investments that generate income: Rental property

• You may be interested in investing in rental property with the expectation that it will generate income through rent as well as appreciation of the property and home or building.

Within each of the categories you can find investments of varying levels of risk.

Typically investments that are expected to increase your capital through growth are more risky than investments that are simply expected to generate income.

Each tier of the pyramid requires attention if you want to become masters of your own personal finances.

However, there is somewhat of a hierarchy. You need to examine your financial situation and where you would like to be financially before you can choose the investment vehicles, strategize, and choose specific investments to achieve your goals.

Final Thoughts

Building your own personal financial pyramid will help you achieve your goals both in the short-term and long-term.

Let’s recap the steps to set up your personal finance pyramid:

• Get familiar with your current financial situation and your goals.
• Figure out your strategy: how do you get to where you want to go.
• Build your investments: determine how much risk you’re willing to take and figure out different streams of income – aka diversifying your investments (we’ll talk about this soon!).