Yesterday in our “back to basics” series we focused on how to gain an overview of your financial health. We also explored why knowing your top three financial goals is critical to your success. Today we climb the so-called “Risk Pyramid” and highlight five investment purposes.
Like the U.S.D.A.’s Food Pyramid, a personal finance “Risk Pyramid” is open to debate and interpretation. Still, it’s handy to know what the experts recommend. I take this overview from Paula Ann Monroe’s excellent book, “Left-Brain Finance for Right-Brain People”, (Chapter 6).
Here’s the structure of Monroe’s version of a Personal Finance Risk Pyramid:
Foundation – Shore Up The Basics:
Property, Casualty, Liability Insurance (to protect your assets)
Healthy and Disability Insurance (to protect your health and also your income-earning potential)
Life Insurance
Emergency Fund (I like to call this the “Emergency Prevention Fund”)
Personal Residence
Specific Savings Goal or College Fund
Retirement Plans
Income
Bonds and Government Securities
Income Mutual Funds and Blue Chip Stocks
Growth and Income
Rental Real Estate
Mutual Funds and Limited Partnerships
Growth
Common stocks and Growth Mutual Funds
Growth Limited Partnerships (e.g., movie rights, commercial real estate), Hard Assets, (e.g., works of art, precious metals) and Land (you know what land is…)
So, from bottom (basics) to top (growth) these are the financial components that make up your personal finance “risk pyramid”. As you move toward the top the investments have more associated risk.
Yes, owning empty land is one form of “risky”. This is one example where folks disagree on risk pyramid structure. Sure, they aren’t making more empty land. Unlike other investments, land value is associated with uncontrolled nearby conditions. In contrast, an asset on that land (like a home) could always be sold off or insured for financial protection against an unforeseen event.
How do you evaluate all these different investments? It breaks down like this: look at each asset in the pyramid on these criteria. Compare what you find to your goals, your tolerance for risk, and your specific situation. Here are the things to consider:
Safety
Liquidity
Income
Tax Advantages
Growth Potential
If you’re a beginner, focus on strengthening the base of your financial risk pyramid. Educate yourself and get professional opinions before attempting more sophisticated investment strategies. Use Geezeo’s tools and social resources to make more informed choices.
Finally, and the most important: finding purpose in your investments is a head and heart activity. Use your head to evaluate and implement your investment strategy. Use your heart to determine why you want to improve your financial situation. Incorporate giving to others as part of your strategy and you’ll find true purpose to stay financially fit.
Climb that pyramid!
October 19th, 2008 at 2:36 pm
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