Monday, September 30, 2013

Three Levels of Financial Maturity

Three levels of maturity. Photo: Creative Commons.
It's a jungle out there - so it's important to have the financial world working with us rather than against us.

In evaluating individual financial situations, I find it helpful to use three categories. For want of a better term, I call these "levels of financial maturity." (Financial maturity, as I define it, and personal or psychological maturity are completely different matters.)

The goal is to rise from one level to the next. The definitions below are my own:

  • Financial Independence: Able to survive without employment income. Although we think of financial independence as being wealthy, many are not. The majority in this group are retired and on Social Security and Medicare. These government programs do a lot for financial independence (although they cannot do it alone).

  • Financial Maturity: No junk debt, probably no Home Equity Line, although perhaps an automobile loan. There likely is a mortgage. A 401k or IRA is being funded.

  • Financial Immaturity: Characterized by the presence of junk debt. Junk debt is any debt which is unsecured, such as credit card and department store cards. I would include a Home Equity Line here as well.

Note: these terms are not judgmental! We can be personally mature, hard working, etc., but in the "financially immature" stage or vice versa. For example, many families and students have credit card debt, and these individuals are foundations of society. It's part of life.

At the Financial Immaturity Level, the World of Finance Works Against Us

What I really mean by Financial Immaturity is that at this stage the world of finance works against us. "It's arithmetic," as someone famous recently said, and the arithmetic is not in our favor.

Here we're paying compound interest, perhaps at exorbitant rates. This makes it difficult or impossible to get ahead. It's not a fun way to live life. Don't expect help though: there are plenty of financial institutions that are likely happy to have folks remain in this stage.

The question is how to break out. How to move to financial maturity, where financial instruments begin working in our favor. Where we'll be swimming with the current rather than against.

The Solution is an Emergency Fund

In my next post, I'll talk about the single most important step to take to move out of financial immaturity This is the development of an emergency fund. An emergency fund may sound boring, but it's not if used as I'll discuss.

An emergency fund may be the single best thing that can happen to personal finances.  The good news is, with the information which I'll share, the transition may be easier than most of us would imagine. Stay tuned.