If you’ve ever taken a psychology course you may be familiar with Abraham Maslow’s Hierarchy of Needs. In ascending order, the needs are:
- Social / Belonging
- Esteem / Achievement
- Self-Actualization / Reaching your potential
The theory states that people need to fulfill their basic needs before devoting energy to the higher levels. So, for example, you can’t focus on your job (safety) if you are hungry or haven’t had enough sleep, and you can’t focus on friendships or reaching your potential if you are about to lose your job.
The hierarchy of needs is simply a way of setting priorities in your life.
Hierarchy of Financial Needs
We can also apply a similar concept to prioritizing our financial needs. Although every individual faces their own unique circumstances, the model is applicable to all demographic groups – whether you are starting your first full-time job, or finally handing in your nametag after a long career.
When you’re thinking of your finances your first consideration shouldn’t be how to invest your money when you are having trouble paying your bills.
The first step is to know what, how, and in what order things need to be done. Begin at the bottom of the priority pyramid and work your way up.
Level 1 – Basic Necessities
First you need to construct a solid base. We need to fulfill our basic needs before we can move on to the next level. The most basic financial need is income to cover your necessary living expenses of food, shelter, and clothing.
This level is also where wants can masquerade as needs.
I’m not suggesting living in a shack and eating a steady diet of canned beans in order to cut expenses before you can move on. But, you know you generally buy more than what you currently need, whether it’s every number of iPhone to get a smaller/bigger screen or a few more pixels, to buying a 5000-square foot home for two people to rattle around in.
I know it’s cool to brag about all the options and gadgets in your new auto or kitchen appliance, but I’ll bet in the long run you don’t use the majority of them, or even bother to read the instruction manual to see how to use them.
Level 2 – Security and Safety
Life is full of uncertainties. Always have a fall-back in case of unexpected events that can create setbacks.
Once you have your basics under control you need to protect your earnings with life and disability insurance. Protect your assets with auto and home insurance.
Invest in your career to secure your future employment.
An emergency fund also fits into this level as well as will and estate planning.
Retired people need a safe pool of money to draw on for a few years in case of a stock market downturn.
Level 3 – Accumulating Assets
Once you have protection, it’s time to grow your wealth.
To acquire some assets like real estate, you may need to leverage credit to acquire the necessary capital. Paying off debt is a form of savings, too. The best return on your money is paying off credit card debt. This will always boost your bottom line.
Invest for future returns to attain important life goals such as future financial security.
This is also the time to plan for your retirement. Remember, the money you save now will be spent by the future you.
Level 4 – Enhancing Your Life
Save for specific goals that will enable you to do the things that bring joy into your life like enjoying family activities and entertaining friends.
We all need a few luxuries. It could be anything from travel or buying a vacation home to enjoying hobbies and drinking fine wine.
Level 5 – Financial Independence
Financial independence means you are able to live on income from pensions, investments or passive income such as dividends, royalties and rental income. It often refers to the retirement years, but it can also mean the freedom to work how, when and where you like. It means not having to worry about money.
Level 6 – Leaving a Legacy
Okay, I added a level. You leave a legacy by making a difference in someone else’s life. Make charitable donations to a cause you believe in. Help your children or grandchildren with their education expenses or start a business.
In much the same way you master each level in your favourite video game before moving on to the next, prioritize your financial decisions in order.
The bottom three rungs in the hierarchy of financial needs make up your foundation. Once they are in place you can move on up to achievement and your full potential.