A few years ago, I met with a financial advisor and she informed me that there were 3 pillars of financial stability. With each of these pillars in place, you build your finances with a structured approach. The idea is that if any one of the pillars were knocked out, the structure would not stumble right away, but you would repair / rebuild that pillar as quickly as possible. The pillars are: savings, investments, and insurance. The principal is sound, however, she left out one key element…the foundation.
Foundation of financial stability
But why do you call Me ‘Lord, Lord,’ and do not do the things which I say? Whoever comes to Me, and hears My sayings and does them, I will show you whom he is like: 4He is like a man building a house, who dug deep and laid the foundation on the rock. And when the flood arose, the stream beat vehemently against that house, and could not shake it, for it was founded on the rock. Luke 6:46-48
The strongest structure will not stand on a weak foundation. A structural example of this is the Leaning Tower of Pisa. Although intended to stand vertically, the tower began to lean soon after its construction because it was built on a poorly laid foundation. Our financial foundation are the principals of biblical stewardship and giving. Once this foundation is laid, you have the potential to build wide (diversity) and high (wealth, profit and increase).
The pillars promote a balanced and diversified approach to financial stability. Conventional wisdom dictates you should not put all your eggs in one basket. Using the pillars as an example, it may be tempting to build the savings pillar without any regards to insurance. A medical problem could wipe out months, even years of savings. The Bible also supports diversification:
Divide your portion to seven, or even to eight, for you do not know what misfortune may occur on the earth. Ecc 11:2
Let’s take a closer look at some of the building blocks that make up the 3 pillars. In the diagram, I placed savings in the middle because it is the load bearing beam. If you are beginning to build, I recommend starting here.
Sure you could save money like grandma used to by stuffing it under a mattress, but there is absolutely no security in that! Find a bank or credit union that is backed by the FDIC or NCUA respectively to insure your money. Build an emergency fund large enough to match your situation and comfort level. The personal finance experts cannot agree on the amount. Some advocate 3 months of expenses, and others advocate as much as 9 months. Consider the following factors and set a goal/amount that works for you.
- Risk tolerance
- Stability of income stream(s)
- Number of income streams
- Number of dependents
- Other assets
Savings should be secure, low/no risk and accessible when needed. Traditional savings accounts at a brick and mortal bank or an online high yield savings accounts are appropriate for an emergency savings stash. As your savings accumulates, check to see if you are eligible for a money market account. Money market accounts work like regular bank accounts except they have higher interest, a minimum balance, and a low limit on the number of withdrawals allowed per month. This is an excellent fit for an emergency fund as interest will accumulate.
Another building block in the savings pillar is the certificate of deposit (CD). CDs have a fixed term and typically a fixed-rate. There are withdrawal penalties, so this is something that should not be considered for an emergency fund. Generally, the larger the principal deposit and term length, the higher the interest rate. CDs attract conservative savers and investors because of their low risk. However, the return is low for the amount of time your money is held up. The CD laddering strategy attempts to alleviate this. The idea is to start several CDs at the same time at varying lengths (example: 1yr, 2yr, and 3yr). As the CD matures, it would be reinvested at the 3-yr term (highest interest rate). Eventually, all the CDs will be invested at the 3-yr term, however one would mature every year. Giving you a bit of flexibility.
Insurance is like bitter pill. We take it because we know it’s good for us, but no one really wants to. However, having insurance is the responsible thing to do, and in some cases it is required by law. There is insurance for everything under the sun! The key is to make sure you have enough of the right kind of insurance.
Probably one of the most popular insurance decisions will be whole or term life insurance. Term insurance is the cheaper of the two. It provides coverage for a predetermined amount of time (eg. 30 years). Whole, or permanent life insurance is open ended, providing coverage as long as you pay the premiums. They also accumulate a cash value. Generally speaking, there are better mechanisms than a permanent policy. If you are disciplined in your investments, you may not need to rely on a life insurance product to save for you. To see where you line up, use bank rate’s insurance calculator.
If you are going to operate a motor vehicle, car insurance is a requirement in every state. The amount of minimum coverage varies from state to state. A 2006 report from the Insurance Research Council estimates more than 14% of drivers are uninsured. The penalties are hefty and not worth jeopardizing your financial stability. Don’t do it!
Selecting the amount and type of insurance is a delicate balance between cost and peace of mind. Not enough insurance and you may find yourself unsettled and in dire straits should a need arise. Consequently, if you spend too much on insurance, you may not have enough to save or build the third pillar…
Unlike savings, where your money is stored in a safe, accessible manner; investments involve risk with greater potential for gain over extended periods of time. The primary focus of investing is increasing your net worth and achieve long term financial goals. The amount and types of investments you choose will vary according to your risk tolerance. The market fluctuates and your portfolio graph may look like the latest thrill roller coaster. However, over long periods of time (10 years or more), the market traditionally increases between 8-10%.
Popular investments include
- 401 (k) retirement plans – Many employers will match a portion of your contribution
- Individual Retirement Accounts
- 529 College Savings Plan – Each state’s plan is different. Shop around! You don’t have to select the plan in your state of residence
- Mutual funds & Exchange Trade Funds
Of course there are plenty of other entities not listed here. This is not meant to be an all inclusive list. When you start with a strong foundation and these 3 pillars, you are on your way to building financial stability.
What does your blueprint for building financial stability look like? Do you use the three pillars listed? Could you include more pillars? Less?