hierarchy of investments

Confused about where to invest — Just follow this Chart (Read if you must)

We get that investing for the first time can be a confusing mess—you don’t know where to put your money. All you think about is the formula: profit versus risk. To get a fix on that, you were told to get all the numbers and facts about the investment instruments before going ahead. While this is standard procedure, there is again the danger of becoming emotional about it. What I mean is that too much digging on all the numbers and facts can be overwhelming and you end up afraid or hesitant of proceeding with investing at all. Indeed, as the Chinese sages say, “the journey of a thousand miles begins with a single step”, rings true here. If you saw the whole length of your journey (all the facts of the investment), I wonder if you’ll still have the courage to invest. You’d end up becoming pessimistic.

It’s a Marathon, Not a Sprint

What you need to understand, however, is that common assessment on profit versus risk should not be understood as a race to make money. Investment, ladies, and gentlemen, is not a sprint; it is a long-drawn marathon. Those who profit a whole lot in investments were not geniuses. In investments, your brain and your heart only play a minor role, what you need is a strong gut. You have to be able to stomach the roller coaster ride of the market.

To be able to have a strong gut, good investors pitch in their money with an ideal that is higher than getting profit. Thus, as any financial adviser would tell you before you invest you need to have a long term plan. Basically, you need to ask yourself, what is the purpose of my investment? Are you saving up for your future wedding, your child’s tuition fees, your retirement, etc?  Profits planned in isolation would be a fruitless endeavor.

Principle-based Investment

You need to have a plan so that you’d be objective in your perception of investment. It must be a plan that you truly believe in. A plan that is based on your principles. You’d toughen up if you know that you’re investing because you have a dream so you’ll stick with it.

So do would we perceive our investment objectively? In our earlier blogs, we’ve discussed the difference between needs and wants. Needs are those that you cannot live without (food, shelter, water, electricity, etc); Wants are things we buy because we’ve been drawn emotionally toward it. With this, you have to look at investment as a Need, not a want. It’s something you have to do so that you could establish a strong financial foundation for yourself. You cannot be secured financially if you don’t invest.

The always-reliable chart of Maslow

Still, the definition of Needs can be quite obscure. If you can remember Abraham Maslow, an American psychologist, didn’t he arrange needs into a hierarchy? Here’s how he did it:

Maslow’s Hierarchy of Needs

When you start to invest, needs should also be arranged in a hierarchy, which should look like this:

The Investment Hierarchy of Needs

As you would notice, our common understanding of investment is placed on top of the pyramid, which means putting your savings immediately to stocks and/or mutual funds is really not a good idea. Doing investment properly is to start from the bottom (healthcare), make each step (protection, debt elimination, emergency funds), before going into that luxury of buying stocks and real estate.

Investment for Beginners: It isn’t about what your gut tells you, but what you can stomach at the moment

Now, you seem to be asking why investment is arranged this way. Again, as we’ve mentioned, good investing is about how much you can able to stomach the risks involved—how much damage can you take in case there is a recession. We certainly don’t want to urge you to invest in high risk-high yield stock, when you’ll end up broke the moment the market goes down. Investment requires different levels of maturity in assessing risk factors The hierarchy of investment then serves as a blueprint to help you minimize your risks. It would help you become more mature in dealing with the market.

Healthcare first

So for beginners, invest in your health first (you won’t go far with your savings goal if you’ve been stricken with a heap of medical bills because of your poor health); then move on to insurance protection (you need to protect your family in case something happens to you). In case you die too soon, wouldn’t it be better if your family with money rather than debts? Third, in the hierarchy is to focus on eliminating all your debts. Debts left alone would become worse over time as interests keep rising against you. Debts would pull you deeper and deeper into financial woes if you don’t do something about it now.

Emergency Funds

If you’ve succeeded in eliminating your debts, it’s time to build your emergency funds. The emergency fund is money you can get as soon as you need it. Historically, the real function of credit cards was to provide you with immediate funds in case of emergencies. Somewhere along the way, through deft advertising and marketing, we were swayed that credit cards are for shopping purposes.

The average amount of an emergency fund is the amount of your monthly income multiplied by 10. In case you lose the ability to earn income temporarily, you and your family can survive for at least 10 months. Now to save emergency funds, financial advisers would tell you to divide the amount of your savings into two: 50% goes to your savings plan, while the other half to your emergency funds.

Remember investment requires the guts to hold on. It always involves an accompanying long-term plan or dream you set for yourself. To look at it objectively, investment should be treated as a Need. The hierarchy of needs is a set of instructions to guide you in building a strong financial foundation. So by the time you begin pursuing the high-yield-high-risk investment instruments, you don’t worry about losing, regardless of whether the market goes up or down. All you think about is your goals, your dreams, and going BIG.