May 2023 Newsletter
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Hi all,
A friend asked me a question a few months ago about what she should do with the $30,000 in her savings account. Another friend also asked me where she should put her hard-earned money away? I answered the questions via text messages and felt proud that I was the trusting person whom my friend can turn into.
Now I put my answers into a blog post, which needs more reference resources. So, as normal, my blog post is still long, but it may help explain why you should follow the advice but sometimes you don't.
A lot of Americans have known about Maslow's pyramid since high school. My friend in Vietnam, who specializes in Psychology knows about it, but I didn't know about it until learning about finance.
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| Simplified hierarchy of needs - Maslow from Wikipedia |
We work. Everyone works. Since the primitive era, human has worked for food, water, and shelter for rest and warmth. Then we want to find a stable place to stay and build our family for a longer time, usually for generations. In the modern time, we have to work for money to buy food and water to keep ourselves full and warm. We need money to pay rent or mortgage for our home. Those are the physiological needs - the survival level of the pyramid.
Nowadays, there are still a lot of people struggling to have food in their bellies and roofs above their heads. 42 million Americans - or 12.6% of the nation - are using SNAP, Food Stamp Program for low-income working Americans, as well as the disabled and the elderly.
There are also millions of Americans experiencing homelessness while 9.3 million Americans get help from Housing Assistance Program.
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| State of Homelessness |
You may know someone who is using the Food Stamp and/or Housing program. In a Facebook group I have joined, an admin also shared that he narrowly experienced homelessness after being laid off and have nothing to pay rent. That's also a fact that when you lose your job, you may have no money to survive.
Maslow's idea is that you must meet your most basic level of human needs before you can meet your higher-level needs.
So, when you have your extra money, and don't know what to do with it, Maslow's pyramid can guide you.
Look over the pyramid and see if you can build your foundation steadily. Do you have enough money in your checking account for expenses for a month like money for food, water, transportation, utility, and health care expenses?
From the basic needs, we build our emergency fund. The amount you must save should be all the expenses for you and your family from 6 months to a year.
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| Source |
For example, if the expenses for food, water, heat and electricity, clothes, home, transportation, health expenses (health insurance premium, copay, and deductible), and other necessities are about $3,000 a month, you will need about $18,000 to $36,000 for an emergency fund.
This fund will be used to pay for those expenses in case you get laid off, sick, or injured for a few months. Keep your emergency fund separate from your checking account so that it is harder to dip into.
Creating an emergency fund gives you a cushion so you don't have to go into debt to meet an unexpected expense.
Congratulations on your fulfillment of survival needs!
After checking that your survival needs are guaranteed for at least 6 months, you can move up to level 2: safety and security. At this level, you may have your income increased by promotion, switching jobs with higher pay, or doing a second job.
At this time, you need protection for the basic needs at level 1. What will happen if the breadwinner dies? Then you need life insurance for the breadwinner. The stay-home parent also needs it too. Term life insurance is affordable when the insured are young and healthy.
What will happen if the breadwinner gets sick or injured for over a year? At this time, the emergency fund has been exhausted.
If the company covers you with short-term disability insurance, you can get help. However, the short-term disability insurance covers you for 6 months, and the long-term one covers for 2 years maximum.
A private disability insurance policy you bought with your after-tax dollar will kick in when you need more time to recover. Disability income insurance is pricier so you may want to wait for the time that your income increase to get it. Remember that the ability to create an income is the asset that needs to be protected the most.
Then you may want to save for the long-term future: retirement. If you want to have a secured retirement, you should save money as soon as possible. You can put money in 401(k) or Roth IRA because you need time to make your money grow. It takes you more than 30 years to retire, and it's the same time length for money to grow well with the power of compound interest.
After fulfilling your basic needs, you will want to use the money for psychological needs. You have extra money to invest in relationships for your belonging needs or in things that make you feel significant for your esteem needs.
However, a lot of people think that people will look down on them if their clothes look cheap. They use credit cards to buy luxurious items before thinking of securing their income. These behaviors prove the validity of criticism of Maslow's theories that needs don't follow a hierarchy.
Similarly, a lot of people still donate to charity or help others in spite of having difficulties making ends meet.
However, if you want to have financial freedom, Maslow's pyramid can guide you on where to put your money.
Amy Fontinelle wrote on Mass Mutual blog about this financial pyramid and broke down levels of money you can budget. This may not be an official guide, but when you find it hard to see the financial picture clearly, this can help you make your own decisions.
Maslow's theories also meet Retirement. In the book Retirement Income Redesigned, the authors Harold Evensky and Deena B Katz make a close correlation between the hierarchy of needs and planning for retirement.
Based on the hierarchy of needs, you can have a clear vision of where to put your money first. With this picture, you will know where to put your money first when you get your paycheck.
Survival money: The amount of money you need to survive: food, water, rent/mortgage, transportation, and health care cost. An emergency fund for survival needs can be in this category.
Safety money - or what-if money: You will want to protect your life. This could mean life insurance and disability insurance. You may want to save more to move your home to a more secure place or buy a security system for your home. If you have high-interest debt, pay it off.
Freedom money: Do you have the freedom to retire early and do what you want? Then you should save for your retirement first. A portion of freedom money can be used to do the things that bring joy and fulfillment to your life. The money can be used for travel, education, or fine wine. You may want to save for a downpayment for your home. Someone can use this kind of freedom money for riskier investments, which wouldn't affect the family much if he lost it. Building wealth for your family can be a big goal in this category.
Gift money: You can give your kids better education by saving for their college tuition. You can help your aging parents or relatives. Or you can donate to your favorite charities. A lot of people don't wait to be rich to give.
Dream Money: This is for your dream: a dream journey, hobby, or anything luxurious you can think of.
Breaking down your income needs could be a way to track your progress toward financial freedom. You can decide the portion of Freedom, Gift, and Dream Money, and change the order based on your goals, and the time you need (short-term or long-term).
So, going back to my friend's answer, I hope that you can have your own answer. If you have enough survival money to last for a few months, then you should check if your emergency fund is enough. Then you move up to Safety money. For the 3 other kinds of money, you can decide the portion of money you need to put in.
I use another picture to illustrate how a paycheck can be distributed.
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| Illustrated by Milky Way Retirement |
You may not agree with Maslow's theories about the order of needs, but all of us need things to survive. As I'm doing yoga, the foundation is the most important. When you have a stable foundation, you and your family can overcome challenges more easily. From that certain expense for survival, you can free your mind to do other things you dream of.
May you use your money wisely.
Milky Way Retirement
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