What motivates you? What’s the driving force behind your actions? What’s your ‘why’?
According to psychologist Abraham Maslow and his work, “A Theory of Human Motivation”, individuals are motivated by a hierarchy of needs. In this paper, Maslow describes that people are driven by their unmet needs.
At first, we start by pursing our most basic needs. As these needs get satisfied, we progress higher to more advanced, unmet ones.
The same is true in personal finance. Your Hierarchy of Financial Needs get met in a particular order. First, you focus on meeting your most basic needs. Once they are satisfied, higher ones emerge which motivates you to pursue them next.
Needs are subjective. They mean different things to different people. Yet, everyone still meets them in a particular order.
There are 5 stages in Tightwad Todd’s Hierarchy of Financial Needs. They are Financial Survival, Financial Stability, Wealth Accumulation, Financial Independence, and Legacy.
Our most basic need is to survive. If we don’t, then nothing else matters.
Financial survival starts with receiving money to spend on your basic needs to live. These items include food, shelter, and clothing.
Many people begin their financial lives under their parent’s roof. Their family provides their basic requirements until graduation. After this, they are ‘kicked out of the nest’ and are on their own for the first time.
In order to support yourself, you need an income source. Most people start by getting a job to meet their basic survival needs and living expenses.
Some people don’t make enough money to meet their needs and are forced into debt. This is the only time it’s acceptable to take on consumer debt. This should only be used for your needs – not your wants!
Once your financial survival needs are met you will naturally progress forward to the next step.
The 2nd phase in the Hierarchy of Financial Needs is stability. This step is necessary to ensure you don’t slip back into financial survival mode.
With your most basic needs met, you begin to focus on risk. The primary way to avoid the possibility of going backward is to save.
Start with your emergency fund. Save at least 4 months worth of your living expenses and set it aside in a high interest yielding account. In times of financial uncertainty be sure to increase it to 6 months.
The foundation of financial stability is controlling your money. You can achieve this by creating and sticking to a budget.
Many people are forced to take on consumer debt during the financial survival stage. Part of becoming financially stable is starting the process of reducing your debt.
As you live below your means while on a budget, you will begin to have a monthly surplus. This allows you to direct your excess income (aka savings) into very low-risk investments. These include high yield savings accounts, savings bonds, and money market accounts.
Financial stability is characterized by having a reliable income, living on a budget, and paying monthly obligations on time. All of these, allow you to build an emergency fund and start saving for your future!
Once you reach financial stability, you can begin to focus on the accumulation phase. This is the stage most people spend the majority of their lives in.
If you have not already done so, finish paying off your high-interest rate debt. According to WalletHub, the average interest rate on credit cards is over 15%! Paying off these obligations gives a guaranteed 15+% risk-free return on your money!
Focus on your budget. Concentrate on increasing your income, maximizing your savings, and spending intentionally on the things that are most important to you. These 3 key areas will help you save more money.
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. Ensuring that you work longer to meet your financial goals.
Most people start investing through a 401k. You should contribute enough to maximize the amount your employer matches. Also, check your qualifications and look into opening additional tax-advantaged accounts. These include a Roth IRA, HSA, and 529 Plan.
Once you have funded your retirement accounts, put your remaining capital towards your other goals. Consider opening a low-cost brokerage account to invest in stocks and bonds. Also, explore the benefits of owning rental property.
As your wealth grows you may consider more advanced techniques. Depending on your age and risk tolerance, it could make sense to take on additional risk. I recommend investing in risky assets earlier in life. This gives you more time to recover if there’s a loss.
As your riches grow consider your money mindset surrounding risk and debt. Some investments allow you to take on low-interest-rate debt to generate higher returns. Thus, making your money work even harder for you!
The wealth accumulation stage is the longest. It takes most people decades to progress forward to the next step. Some may lose sight of their goals in the process.
During this stage, people have more money than ever before. Unfortunately, this can sometimes cause them to become distracted and take their foot off the gas.
Stay focused on your goals and spending. Have a plan for combating lifestyle creep. And most importantly, maximize your happiness through intentional spending.
Review your financial needs every year. Many parents have children that leave home, which could present the opportunity to downsize or change certain spending habits. Taking these actions could propel you higher towards freedom!
During the wealth accumulation phase, test out your new upcoming lifestyle. Find out what you like about it and any potential pitfalls you may face.
Also, think about how you will spend your time. It can be overwhelming to go from being time-constrained to having so much more free time than ever before.
I went from having a 50+ hour weekly commitment to a 5 hour one. It was not only shocking, but a struggle for me to have such a surplus of free time. So, plan ahead and know what you want to do with all your new-found freedom!
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!
There are 3 main strategies for reaching financial independence. They are retirement savings, the 4% Safe Withdrawal Rate, and passive income. Most people use a combination of all three to reach their own version of financial freedom.
For years I imagined achieving financial independence. I dreamed of being a nomad and traveling the world. So I did! I was able to walk across Northern Spain, surf at world-class breaks in Indonesia, and explore Thailand by motorbike! All these once in a lifetime experiences would not have been possible if it weren’t for financial freedom!
Personal finance is personal. There is no right or wrong way to achieve financial independence. Determine which works best for you and start.
The top step on the Hierarchy of Financial Needs is your legacy. You have put in a tremendous effort your entire life to get to this point. Yet, your work still isn’t done!
In a recent Conference-Board study, they found that almost half of the workforce is not satisfied with their jobs. That’s a lot of people and gives good odds that you are one of them, too!
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.
Take some time to reflect on the following:
The goal of life is not a self-serving one. But, one that allows you to share your special talents with the world. We all have them.
Give back. Use your gifts and spend your money to leave a legacy. Further the causes that are most important to you.
Make it your goal to arrive at the legacy phase as quickly as possible. It could be the point at which your life’s work begins. After all, you now have the time and resources to make a difference!
The Hierarchy of Financial Needs has proven true throughout my life. When I graduated from college I got a job. It provided for my basic needs and allowed me to start saving. Less than a year later, I was laid off. Immediately, I carefully watched my spending and lived off my emergency fund. I did this to make sure I didn’t fall back into survival mode.
A few months later I found another job. This one met my basic needs and allowed me to focus on saving again. As my money grew, I was able to fixate on accumulating wealth and working towards financial independence.
Once I achieved FI, I quickly realized my work wasn’t done. I wanted to leave a legacy. It took fulfilling each of the previous stages before I understood what I wanted next.
As you advance through the Hierarchy of Financial Needs a pattern develops. Each stage requires that you learn and build upon previous knowledge to progress higher.
Successful people never stop learning and setting goals. These two habits show up over and over again on the Hierarchy of Financial Needs. They are necessary for you to move forward.
Commit today to achieving financial independence and retiring early. Leave your legacy and help make the world a better place!
What goal can you set today that will push you forward to the next stage of your hierarchy of financial needs? Comment below.
Retirement and estate planning may seem like a distant concept for those in their 20s…
Who doesn't desire a life filled with joy, abundance, and freedom? However, many of us…
Are you feeling overwhelmed by unexpected expenses? Puzzled by the state of your bank account…
Many people think their friends are wealthier or don't experience the same financial difficulties as…
Most of us start our adult lives as consumers. We work hard for our money…
There's a myth that self-care is expensive. People think they need to drink expensive smoothies…
This website uses cookies.