In previous posts, we have reviewed the 7 baby steps in Dave Ramsey’s book, “Total Money Makeover“. Ramsey shows that, by using these steps and following them in sequence, anyone can eliminate debt and start making strides toward accumulating wealth. Once, you have reached baby step 7 where you start building wealth, you will have a better understanding of what it means to save.
Creating the Foundation for Wealth. It was Benjamin Franklin who said, “An investment in knowledge always pays the best interest.” Old Ben would also probably agree that Ramsey’s Total Money Makeover is a testament to this fact. It is from this book the reader is inspired to save and build the right financial base for creating wealth. For example, as part of your financial base, you should develop a good financial plan. List your budget, net worth, and long and short term savings and spending goals in the plan. Include sufficient financial protection in the form of life, disability, health, property, and liability insurance as well.
Create a Savings Pyramid. You can build on this base by creating a savings pyramid. On the lower tier of the pyramid, include cash savings, or money that can be readily accessed for emergency expenditures. These funds are part of your short term savings.
Medium Term Investments. On the next tier of the pyramid, you want to include medium term savings instruments, such as corporate and municipal bonds that provide a little more interest but are fairly safe. Here, you will be placing your money in investments that you will not need for three to five years. You can either trade the bonds or hold them until they come due, also known as mature.
Longer Term Investments. Moving up to the next tier of the pyramid, the investments take on a bit more risk. Here, your money should be channeled toward long term investments, such as stocks or mutual funds, where you will not be needing the proceeds for five years or more.
Top of the Pyramid. At the very top of the pyramid, you will find the riskiest investments. A good example of a high risk investments are an aggressive growth mutual fund, real estate, commodities, peer-to-peer lending like Lending Club, etc. Companies in these kinds of mutual funds usually show the potential for growth and feature a substantial amount of volatility with respect to the price per share. Many of these funds will also include options in their portfolios to enhance the rate of return. Therefore, if you want to obtain a higher rate of return, you will also assume a greater amount of risk. That is why organizing your savings and investments are important if you want to stay on track with regards to building wealth.
Savings for the Long Term. Consequently, you can use the idea of a savings pyramid to help you balance and diversify your bond and stock mutual funds and investment accounts. Diversification is helpful in leveling out the expected ups and downs. Building wealth, typically, is not a short term process and should not be viewed as such. It requires that an individual take a protracted view of their savings and investment picture. This means contributing regularly to your accounts and keeping the money there for a designated length of time.
By allocating your money in specific investments, you can stay on course with your individual financial goals and live with peace of mind and a feeling of security. Using a pyramid is a great way to visualize how risky your portfolio should be and how to allocate your money across asset classes.
Ramsey’s program and book, “The Total Money Makeover“, include the following baby steps to financial freedom…
- Step One: Save $1,000 for an emergency fund
- Step Two: Use the debt snowball method to pay off your debt
- Step Three: Complete the emergency fund
- Step Four: Invest 15% for retirement
- Step Five: Save for your children’s college
- Step Six: Pay off your mortgage
- Step Seven: Start building wealth