Q: I’m a 25-year-old graduate and am into my second year of employment in a hospital. I am currently debt-free and am thinking about venturing into saving and investing. I’m looking for some direction. I understand that starting early gives me an advantage, but I want to make sure I start out right.
A: As you get better and better at video games you get to move up to the next level. This makes you cool.
Moving up to the next level in mastering your money is even cooler. Trust me. But it can be an overwhelming task. There is so much jargon out there, almost none of which you learn in school. Plus, for most of us, money topics are really boring.
Developing your financial skills is like a game only the stakes are much higher. You have to work your way up the levels, but it can be hard to figure out where to start. To help you determine where you should focus your energy I developed something called the “Priority Pyramid.”
Figuring out your focus with the Priority Pyramid
The Priority Pyramid is a riff on Abraham Maslow’s Hierarchy of Needs. Maslow was a noted American psychologist who asserted that our most fundamental physiological needs are the bottom of the hierarchy (What am I going to eat right now?). These needs must be met before you can move up to the next level in the pyramid. Our self-actualization needs are the top of Maslow’s hierarchy (What is my purpose in life?).
The same thinking applies to your money. Rather than trying to work on everything all at once, figure out what you need to do first. Once you meet those financial milestones you can move up to the next level on the pyramid. Simple? Sure is.
Moving up the levels of the Priority Pyramid
Cash flow: At the base of the pyramid is cash flow. Are you earning more than you’re spending? Before you do anything else you need to make sure your income exceeds your expenses. If it is, move up to the next level. If it isn’t then you now know exactly what you need to focus on: increase your income and/or cut your expenses. Period.
Debt: Have you eliminated credit card debt? The best return on your money is paying off that debt pronto. You’ll save anywhere between 15% and 30% in interest—guaranteed. Try getting that return on the stock market.
Savings: Are you regularly contributing to savings? The rule of thumb for retirement savings is 10% of gross income. You might also want to save for a house, a vacation or a miniature dachshund.
Taxes: You have a savings plan in place, but are you taking advantage of tax savings vehicles and other government programs? For example, RRSPs, TFSAs, RESPs and RDSPs.
Investment Performance: Don’t be the obnoxious one at the bar, bragging about shooting the lights out with your brilliant stock picks. Instead, focus on basic performance. Are your investments matching the performance of their benchmark index over time? A lot of people simply stop at this level; They are happy with their life and don’t want to invest the time and energy it takes to move up one more level on the pyramid. But if you do….
Optimize returns: At the top of the pyramid, ask yourself if there are other strategies you could employ to maximize your goals. This could include investing in specific sectors or regions, or playing around with commodities or rental properties. But do this only after you have done everything else.
Using the Priority Pyramid in real life:
Let’s say your dad is one of those people who likes to talk nonstop about investing—where, why, how much, and so on. All that is nice, but before you can even think about the “investment performance” level of the pyramid, you need to get a handle on your cash flow. Smile warmly at dad, then shift the conversation to what matters to you, or to one of the twin black holes of discourse, religion or politics.
Let’s say you are further up the pyramid. You’re earning more than you’re spending, don’t have a balance on your credit cards, you save 10% of your pay every month, and that money goes directly into your RRSP. At that point you would focus on investment performance and compare the performance of your investments against your benchmark. You’re still not talking to your dad about junior mining stocks, but you’re closer.
Win the game by focusing on your No. 1 priority
Once you figure out what your No. 1 priority is, focus on it ferociously. And after you’ve achieved it, proudly move on up to the next level. Like a video game, only with bigger rewards.