Building Strong Financial Foundations: A Guide to the Financial Planning Pyramid
Financial planning isn’t easy. That’s why people work with skilled financial advisors to guide them in managing their financial assets effectively. A financial planning pyramid is a hierarchical structure for building financial stability. Advisors have used it for many years, and it remains an essential tool in modern financial planning.
This article will provide financial advisors with a comprehensive understanding of the financial planning pyramid and practical guidance on implementing it with clients. We’ll explain the logic behind the structure and how it can be used to guide clients to financial stability. Read on for a comprehensive guide to the financial pyramid.
What is the Financial Planning Pyramid?
The financial planning pyramid can vary in structure but typically includes a few levels, ranging from foundational security to legacy planning. The different levels in our version of the financial pyramid include:
Legacy planning (top of the pyramid)
Wealth preservation
Wealth accumulation
Foundational security (bottom of the pyramid)
The financial planning pyramid’s hierarchical arrangement is intentional. Building a solid financial foundation is essential before moving on to higher levels of the pyramid. Financial advisors can communicate the concepts effectively to clients using a visual aid, such as a diagram of the pyramid.
This tool is helpful during initial financial planning conversations to build foundational security and trust with clients. Additionally, advisors can foster meaningful client conversations with Asset-Map. Asset-Map offers visualization features that make viewing a complete financial picture simple.
The Foundation: Building Financial Security
At the bottom of the pyramid lies its foundation. In this case, the foundation is financial security, which is a critical part of reaching financial freedom. Building a solid foundation with the essential components ensures clients are well-prepared to build upon their wealth.
Essential Components
The key elements of the foundational level include an emergency fund, debt management, and basic insurance coverage. An emergency fund should be set aside for small to large unexpected bills or expenses. Emergency funds should typically have about three to six months of living expenses in case of an emergency.
Debts should be managed effectively to minimize interest payments and improve credit scores. Clients should also acquire adequate life, health, and disability insurance coverage to protect themselves.
Practical Advice
Providing actionable advice at this level includes recommending that clients create a budget, pay down high-interest debt, and establish an emergency savings account. Financial planners can help clients pay down their high-interest debt, such as credit card debt, to reduce financial strain and free up cash flow.
Additionally, they can aid clients in developing a comprehensive budget to help them keep on track with their financial goals. Lastly, encourage clients to save money in an emergency savings account for life’s curveballs.
Importance of Risk Management
The foundational level of the financial planning pyramid also focuses on risk management and mitigating immediate financial risks. Immediate financial risks may include job loss, medical emergencies, disability, unexpected home repairs, etc.
Clients can address these risks with proper insurance coverage to protect themselves from potential setbacks. They can use automobile, home, life, health, disability, and liability insurance wisely to mitigate risk.
Climbing the Pyramid: Wealth Accumulation and Preservation
The following levels in the pyramid include wealth accumulation and preservation. Financial planners can guide clients at these levels to build and retain wealth through targeted strategies. From investment planning to asset allocation, there’s much to be done at these levels of the pyramid.
Wealth Accumulation
When working with clients to build their wealth, investing in the stock market, retirement planning, and education savings are all relevant topics.
One of the best ways to build wealth is through strategic investments. Financial advisors can help clients build diversified portfolios of stocks, bonds, mutual funds, or exchange-traded funds (ETFs) to promote long-term growth. Financial planners must work to align investment strategies with the client’s financial goals, time horizons, values, and risk tolerance.
Retirement planning is also an essential part of building wealth. Advisors should encourage clients to contribute to tax-advantaged accounts, such as 401(k)s, IRAs, and Roth IRAs. Financial planners should also work with clients to review any employer matches, contribution limits, and investment options.
Education savings are also a significant part of this pyramid level for clients with children and grandchildren. Financial advisors may recommend 529 college savings plans for tax-deferred growth and tax-free withdrawals for clients’ children's education. Clients who start saving early will reap the benefits and reduce future education cost burdens.
Wealth Preservation
Wealth preservation is just as important as wealth accumulation. Protecting accumulated wealth can be achieved through asset allocation, diversification, and risk management.
Asset allocation involves spreading investments across several different asset classes to balance risk. It helps clients achieve optimal returns over time by not relying too heavily on a certain investment type.
Diversification is strategically choosing investments in different risk classes to protect one’s wealth. For example, if clients buy bonds, they may purchase some in the technology industry and some in the industrial or financial sector. This way, if a particular sector weakens, not all of a client’s investments are impacted.
Risk management can include insurance, hedging strategies, and portfolio rebalancing. These strategies all help reduce the risk of potential losses due to unforeseen events. Wealth preservation strategies can mitigate economic downturns, legal issues, and health crises. Additionally, legal structures like trusts or limited liability companies (LLCs) can shield assets from lawsuits.
Tailoring Strategies
When using the financial planning pyramid, it’s vital to customize strategies based on clients’ goals, risk tolerances, and time horizons. Tailoring strategies ensures that clients’ individual goals are considered and catered to. For example, a young professional with a high risk tolerance and long time horizon may benefit from aggressive growth investments and less insurance coverage than a high-net-worth individual nearing retirement.
Reaching the Apex: Legacy Planning
At the top of the pyramid is legacy planning. Legacy planning is much more than simply transferring assets to the next generation. It reaches deeper, encompassing the legacy clients want to leave behind.
Legacy planning involves defining exactly how clients want to be remembered. This can mean leaving money or other assets to specific charitable causes and ensuring their wealth is distributed according to their values.
Estate Planning Tools
Estate planning tools, such as wills, trusts, and charitable giving, help ensure the smooth transfer of wealth and family values. These tools allow clients to control asset distribution and reduce tax burdens.
Wills offer clear instructions for property and asset distribution. Trusts offer control over asset management, privacy, and help clients potentially avoid probate. Donor-advised funds or charitable remainder trusts are used to give in alignment with personal values while receiving tax advantages.
Asset-Map’s Relationship Maps feature provides improved visualizations of a client's relationship structures to aid in estate planning. Financial planners can visualize the people and entities surrounding a client’s personal or financial life and have beneficiary and relationship conversations.
Facilitating Family Conversations
Open conversations with family members about estate planning and legacy goals help a financial advisor guide clients at this level of the pyramid. Financial advisors must work with multiple generations to design a legacy plan that clients are happy with and proud of.
Asset-Map is a fantastic tool for facilitating client conversations. Utilize Asset-Map to visualize clients’ entire financial picture and help plan for the future.
Integrating Philanthropy
Philanthropy can also be easily integrated into legacy planning to uphold clients’ values and contribute to meaningful causes. Clients may feel passionate about leaving money to a certain charitable organization or even setting up a scholarship fund in their name. Financial advisors can help clients fulfill their wishes to help others through philanthropy.
Guide Clients to Financial Stability
The financial planning pyramid is commonly used as a framework for building financial security with clients. Adopting the pyramid approach gives you a roadmap to follow with clients, simplifying the financial planning process.
Asset-Map can also help financial advisors help clients build a strong financial future. Its visualization features allow clients to clearly understand their financial situation and engage in deeper conversations with their advisor.
Schedule a free demo of Asset-Map today.