I work in construction and in 2014 our family built a new house. When I tell people I “built our house” they look at me intently and wait for me to explain that I wasn’t swinging a hammer. I acted as the general contractor which means I organized the project, answered the questions, and paid the bills.
Being a homebuilder in the utilitarian sense of getting a home built once it’s designed and sold is mostly about project management, fire control (euphemistically speaking), and people. When I started building what I hope is my family’s forever home I had about a year’s experience as an Estimator. An Estimator determines all the parts and pieces (lumber, siding, sheetrock, etc.) necessary to construct the home and builds a budget of labor and material quantities and costs that populate purchase orders. Homes are pre-sold based upon the budget so the budget is fairly important to profit margin.
In order to build a home, there is a large amount of planning and risk management that needs to take place. Design a home that is aesthetically pleasing, functional, and affordable for your situation.
It’s important to also establish a schedule for the construction project and highlight critical path items. Exploring and planning for the risks of a particular site location or a building’s design takes place before ground is broken. Initially planning the construction is just as important as performance during the build.
Once excavation begins and the compaction tests are complete its time to work on the foundation (aka footers). The saying goes that the home is only as strong as its foundation. Forms are built and the concrete trucks start rolling.
There’s a lot of similarities in building a home and strategic financial planning. A great graphic and there are hundreds of versions is the Financial Planning Pyramid which I have an example of below. If building a home is about starting with a strong foundation financial planning is about goal setting and beginning at the base of the pyramid.
In homebuilding, the metaphorical foundation is the design, budget, schedule, and then we move on to the actual foundation of solid dirt and concrete.
In financial planning, after goals are established we start with wealth protection. This often means looking at insurance and legal solutions. Life events such as getting married or having a child often triggers a meeting with a life insurance agent to get term life insurance and disability income coverage. Meeting with an attorney to have estate documents, powers of attorney, and advanced medical directives drafted should also happen around the same time to ensure our wishes are followed.
Without having these basic wealth preservation strategies in place an individual wouldn’t have a strong foundation to move further up the pyramid. They would be exposed to low probability, but very high-risk events. Income replacement or determining the guardianship of a minor child are addressed in case of a loss at this stage. We could spend time on each of these critical topics in the pyramid’s foundation, but let’s narrow our focus to life insurance. Exciting, right?
Life insurance provides piece of mind that financial obligations and future goals will be provided for in the unfortunate event of someone’s death. Purposes for its purchase vary, but often include paying-off the mortgage or other debts, funding a child’s college education, and income replacement. There’s a great article from Blair duQuesnay delineating what life insurance is not, but also introducing us to the form of insurance that is appropriate for most people. Blair writes that:
Typically, your insurance need is high early in life, when you have many working years ahead. The insurance need declines over time, ultimately reducing to zero at some point prior to retirement. This insurance need curve lends itself elegantly to term life insurance. Term insurance, as the name implies, lasts for a certain term; such as 10, 20, or 30 years. Term insurance is the cheapest option because insurance companies know that many of the policy owners will outlive their term and the insurance company will not have to pay the death benefit.
Thanks also to Brian Preston for introducing me to the concept of the diminishing needs of life insurance as you become more financially independent. Here we also learn about one way to determine the amount of life insurance needed and some other nuggets from the Money Guy.
In this wonderful graphic from Fidelity we’re shown how life insurance needs decline as assets grow along with typical life events.
The graphic puts a bow on the topic of why term life insurance fits so nicely as the base of a wealth accumulation cycle. The strategy of purchasing term insurance at a low fixed rate when you’re young and hopefully healthy allows you to self-insure as your assets increase and you become more financially independent.
Lacking a strong foundation when building a home is not a sound building practice. Luckily, the tree house I’ve been building for the last year and a half doesn’t require any building inspections or I would never get us under roof. It’s enticing to skip to the fun stuff, but in financial planning don’t ignore the process and focus your energy on speculating which FAANG stock will go up the most next month only to have a tragic unprotected loss that is unrecoverable occur. Build a rock-solid foundation and let’s get ready to build upon it in the framing stage where the structure of your wealth accumulation strategy is laid-out.