Monday, August 6, 2012

Hierarchy of Wealth

The Hierarchy of Wealth

What better way to start a Monday then some good old money discussions.  Whether you have practically nothing or amassed wads of doe, you will find yourself somewhere within the next topic I want to present.  Based on the concept of Maslow's Needs Hierarchy, I've created what I like to call the Hierarchy of Wealth.

As you can see from the diagram above, the general concept is simple.  You start at the bottom and work your way to the top all the while taking advantage of all the concepts below, but I'm getting ahead of myself. Let's start from the beginning.  At the bottom of the pyramid, we have the concept of "Cash In-Flows".  This is just a fancy way of saying find some way to bring money into your life.  For most of the population this is through the form of a job.  Other options include intellectual property rights, land-lording, etc...  Before you can start moving up the pyramid, you need a stable foundation in the form of a job.

Moving up through the pyramid, we arrive at the "Pay Off Debt" category.  I should have made this  little more specific, but their is good kinds and bad kinds of debt.  Good debt are those loans you use to either improve yourself (student loans), or increase your assets (mortgage).  As long as the interest rate is pretty low, the tax benefits associated with this debt may be reason enough not to payoff.  The debt I want you to pay off is that high interest credit card debt.  When you purchase with your credit card and carry a balance, you are sacrificing more in the future so that you can give yourself less now.  This is absolutely the worst kind of debt to maintain.

Once you have paid off your bad debt, you can start contributing to your 401(k) if your company provides it.  If you have a pension, well then bless your heart, because you are in the rarity my friend.  Depending on your age, you can cater the make-up of your 401(k) to suite your needs.  Starting in your 20's, you'll want to keep at least 80% of your money in equities, the rest in bonds.  For every decade that you age, decrease your stock portion of your portfolio by 10%.  This will make sure you take on enough risk to maximize your wealth without going too crazy.  Make sure to contribute at least enough to your 401(k) to match your employer's contribution.

Once you've setup your 401(k) to run on autopilot, you can now start worrying about investing additional funds.  Opening up an IRA or Roth IRA is the next best option.  In both cases, you can contribute $5,000 individually, or $10,000 joint into a tax benefiting account.  For a Roth, you pay the taxes before you contribute, and with a traditional IRA you pay taxes once you withdraw.  Do a little research on this subject, because there are some income restrictions associated with a Roth.  I also include "Other Investing" in this category, because if you manage to maximize your funds in your IRA, you should be investing the rest of your money in your own home-brewed fund (more on that in the future).

Second to the top is "Tax Benefits".  At this point in the game, you've invested as much as you possibly can, and the only way to get more out of your funds is to take advantage of all your tax breaks.  At this point, consulting with a licensed CPA may be your best option.

Finally, once you've done all the previously mentioned wealth building steps, you have reached the "Maximize Return" peak.  The only thing you can do at this point is to try to maximize the returns in your previous investments.  Keep doing research on your funds, and strategize for the best results.

Congratulations!!!  If you've made it to the top, you are a ruler of your wealth.  Just make sure it doesn't rule you!

Wonderful Moment of the Day: I've started reading "Early Retirement Extreme" by Jacob Lund Fisker.  It's a really good book on the overall mindset and strategies associated with maximizing your wealth.

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