How strong is your financial foundation?
“You can’t build a great building on a weak foundation. You must have a solid foundation if you’re going to have a strong superstructure.” Gordon B. Hinckley
As it relates to our financial wealth, we must have a strong foundation to ensure our financial house doesn’t come crashing down on us when something signficant happens in the market.
Here’s a model created by Patrick Donahoe, CEO & Founder of Paradigm Life, which he shares in his book, “Heads I Win, Tails You Lose: A Financial Strategy to Reignite the American Dream” called the Hierarchy of Wealth. He classifies assets in terms of risk and control; the more control you have over the asset, the less risk you have.
Tier 1
Criteria: Guaranteed, liquid, prudent return, and control
Strategy: Put away 15-20 percent of earned income and establish 6–24 months of living expenses before moving to Tier 2.
Tier 2
Criteria: Control, collateral, cash flow, and consistency
Strategy: Invest in your personal development to make more money, which includes investing in your business. Invest in hard assets like residential real estate that you own, control, and that produces passive cash flow that you don’t work for.
Tier 3
Criteria: No guarantees, limited collateral, no control, or control is relinquished to a professional.
Strategy: Once you have maximized your Tier 1 and Tier 2 assets, Tier 3 investments are next. They provide higher returns and have higher risk. Examples are hard money lending against collateral, or syndicated funds for hard assets such as real estate or commodities.
Tier 4
Criteria: No guarantees, no collateral, speculative, could lose 100 percent of the investment.
Strategy: Tier 4 is speculative investments where you can lose everything. This tier comes after at least 90 percent of your assets are in their respective Tiers 1, 2, and 3.
Unfortunately the approach most are taking with their wealth ends up looking like the opposite of The Hierarchy of Wealth—an inverted pyramid—where the riskiest assets have become their financial foundation and those assets that are the safest and most secure are at the top. When financial change comes like a recession or market downturn, those with an inverted pyramid are wiped out, and those with a solid foundation typically pick up the pieces, take advantage of opportunities, and do very well.
Where do your financial assets land in the Hierarchy of Wealth pyramid?
In our next article, I’ll be sharing the best Tier 1 asset for your financial foundation.
