Asset Allocation Approach to Building a Solid Financial Foundation

Spending below your income is a fundamental law of financial freedom. If you break this law, you become broke yourself. However, it does not end with saving. You need to build a solid financial foundation with your savings, or else you will misappropriate your savings and end up broke all the same. So the big question becomes – what do I do with my savings? I get asked this question all the time – I have so much saved, what do I do with it?

The answer is to start from the foundation and build a structure that can withstand category 5 financial storms. The worst financial storm a worker can face is to lose his or her job (assuming no permanent incapacitation). With a solid financial foundation, you are in charge, you choose whether to keep working or take a year off and do other things, and you decide whether to work for others or do your own thing. Money is no longer an issue. You are free to follow your passion and work for love rather than work for money.

Many people start their financial house from the wall itself, while more ambitious souls start from the roof. They clean out their savings and invest in a speculative investment where the return on their investment is not guaranteed. If something goes wrong, they lose their money, their house, their car, etc, and roll down the slippery slope to bankruptcy.

If we are to look at your finances as a building, the foundation is financial security, the walls are growth and the roof is becoming rich. You have to become secure before you attempt to grow your portfolio before ultimately becoming rich. It is a natural progression. While growing your portfolio, you have to stand on the foundation of security to do this, rather than wipe out your base to fund growth investments. This means outside of your job, you need to be able to put food on the table and pay your bills before you attempt to indulge in luxuries and dream of becoming rich.

To illustrate let’s assume you are an employee. Your financial security is not your job. You have to invest your savings in fixed-income money market instruments that yield predictable income. Examples are fixed deposits, treasury bills, tenor funds, bonds, commercial papers, certificates of deposits, etc. These are all vehicles. Your risk is virtually zero (except the financial institution/government goes bankrupt while you slept). Rates of course vary, but you do not park your money and go to sleep.

As one rate goes down, you change vehicles. Your job is to grow your interest income until it can cover your monthly expenses and bills. When you get here, you can do without your job. You are said to have achieved financial independence. The focus here is income. Your capital remains fixed unless you roll over your interest. You now have your financial security plan in place.

For folks that do not know what to do with their savings, this is where to start. Invest in your financial education and money market vehicles. As you learn (progress in class), you become better at choosing vehicles to achieve your financial goals. By the time your foundation is set and you are ready to grow, you will know what to invest in next.

The next step is growth investments. The aim here is growth and income. You want to grow your money, hence you invest in vehicles that will appreciate in value and generate cash flow. Examples are stocks, real estate, commodities market, forex, etc. The risks and returns are higher. You can lose your money. The mistake many make is to liquidate their money market investments to fund growth investments. You can get away with this stunt if all goes well. Even when all goes well, you may likely forget to return the funds where you borrowed them from – the money market investment.

What many people do is switch finds between the money market and the stock market, depending on which gives better returns. Folks that got their fingers burnt in the last stock market crash know by now that it was not a smart move. Your foundation should always be in place, not here today, gone tomorrow – it should not be jeopardized for short-term gain no matter how attractive. If you misfire, you pay dearly. If you misfire standing on a solid foundation, you can recover quickly.

If you lose your job without a solid financial foundation, you are in a deep financial mess. The reason people try this stunt is that they believe their job is their financial security, hence they can always bounce back after each misadventure. In today’s world, no job is 100% secure. If salaries are delayed, you are in crisis. If you get laid off, well…

By the time you have learned and practiced building a solid foundation and growing your portfolio, you are ready to go for the high stakes. You are ready to become rich. You can become rich by growing your portfolio, but the quickest way to become rich is to start your own business or become a partner or private investor in a business that will make it to the big league. How do you know that that business in the garage will become the next Google or Facebook?

You need to be financially literate, have a good team, sharp instincts and of course, an element of luck, being invited to join before the party begins. This is ultra-high risk and reward. You can become rich beyond your wildest imagination, and you can lose your money before you say Jack! This is not the type of business you put your life savings or children’s school fees into. It is money you can afford to lose. In regulated markets, there are classes of investors and guidelines as to what type of investments you have access to. Private placements are not for every Tom, Dick, and Harry.

When you build a solid foundation, you are well-placed to take higher risks, and better able to recover when things go wrong. You can face Category 5 storms without a blink. I will be taking each component in the next post