Creating a Financial Hierarchy of Needs
Defining, quantifying, and prioritizing our financial goals are the first steps in the Goals-Based investing framework. This process is highly personal and unique to each family and even to each household and individual within that family. Nonetheless, three observations about human behavior tend to accurately describe all of us across families, generations, and personalities:
- Some of our goals are more important to us than others. We worry more about certain needs-level goals and may go to great lengths to ensure their attainment. When these goals are not met, we feel a keen pain of loss. In order to remove our worry over these most basic goals, we need to be nearly 100% sure of their future achievement.
- Until our needs-level goals are satisfied, most of us are unable to envision or plan for higher-level goals. Because these priority-level goals are not as important to us as our needs-level goals, we tend to subordinate them until such time as our more basic goals are met. However, once we are convinced that our Needs are adequately covered, we tend to re-direct our mental and emotional energies toward the creation of new, higher-level goals.
- Those fortunate enough to have attained both their needs-level and priorities level goals tend to shift their thoughts toward self-fulfillment. We express those desires for self-fulfillment through our aspirational-level goals. Whether we attribute this human tendency to evolutionary processes or a divine source, or both, it is clear that our focus tends to shift away from our own physical survival and creature comforts towards finding our “highest and best use” for ourselves, our family, our community, and our society. For many of us, our focus shifts to shaping our legacy.
These observations about human behavior find their origins in the research of psychologist Abraham Maslow (1908-70), who introduced his now-famous “hierarchy of needs” concept in a 1943 paper entitled “A Theory of Human Motivation.”1 In Maslow’s hierarchy, human behavior is “…a channel through which many basic needs may be simultaneously expressed or satisfied.” These needs “arrange themselves in hierarchies of pre-potency,” that is, “the appearance of one need usually rests on the prior satisfaction of another, more pre-potent need.”2
Maslows’s hierarchy is typically depicted as a pyramid, wherein the most basic needs are shown as the foundation and higher-level needs are shown in ascending order: (see diagram)
Esteem Needs will be pushed into the background until the Physiological Needs and Safety Needs are met. When basic needs go unmet, a person may become pre-occupied or even obsessed with their attainment, such that higher-level needs go not only unmet, but even unacknowledged.
Adapting Maslow’s hierarchy to the context of family wealth planning, we recommend that investors organize their financial goals into three distinct layers:
- Needs & Obligations: those “must have” goals related to maintaining current lifestyles and satisfying existing liabilities.
- Priorities & Opportunities: legacy, philanthropy, strategic investment, or lifestyle enhancement goals.
- Desires & Aspirations: those “nice to have” goals to be funded out of capital surplus.
Quantifying the “must have” goals in the Needs & Obligations layer is a time-consuming and sometimes tedious process, requiring extensive cashflow analysis of both current and anticipated living expenses, debt service, outstanding promises to family members (either explicit or implied), pledges to charity, etc.. Incorporating inflation expectations into these cashflow projections is especially important for family members whose life expectancy is long or for portfolios intended to support future generations of the family.
In guiding our client families through the goals-based investing process over the past decade, we have noticed that some families come “pre-loaded” with an inherent knowledge of their Priorities & Opportunities and Desires & Aspirations, that is, they are quickly able to articulate a list of those higher-level goals and assign rough dollar values to each. This is especially true of entrepreneurs and corporate executives, who are accustomed to thinking in terms of cascading goals, capital budgets, and performance measurement. Maslow’s model might suggest, however, that these individuals are able to articulate their higher level goals only because they have met their lower level goals already with a degree of certainty that satisfies their particular level of risk aversion (which is likely to be lower than average).
By contrast, a fifth-generation inheritor of wealth relying upon legacy assets as his sole means of achieving his needs-level goals is more likely to exhibit a high degree of risk aversion regarding those goals. This risk aversion discourages him from feeling confident that his Needs & Obligations will be met; consequently, he is less likely to spend time and mental energy focusing on higher-level goals. There are, of course, ample exceptions to these rules, but for most wealthy families, defining one’s Priorities & Opportunities—not to mention one’s Desires & Aspirations—may necessitate some passage of time or “curing” period after the family is convinced that its Needs & Obligations have been met with an acceptable degree of certainty.
To be counted among the “wealthy” may mean simply having current financial resources in excess of that required to meet all of your Needs & Obligations at an acceptable degree of certainty. Each family defines its needs-level goals uniquely and requires differing levels of certainty assurance that those goals will be met. One family’s Priorities are another family’s Needs.
In Maslow’s hierarchy, all investors are willing to accept a lesser degree of certainty in pursuing their Priorities or their Aspirationsthan in attaining their Needs. This is an extremely important concept, the implications of which we will discuss in next blogpost in a piece entitled “How Confident Can You Afford to Be?”
1 A.H. Maslow, “A Theory of Human Motivation,” Psychological Review 50, 370-96.
2 Portions of this article were excerpted from “A Theory of Wealthy Family Behavior,” by W. Jackson Parham, Jr., in Family Legacy and Leadership: Preserving True Family Wealth in Challenging Times, by Mark Haynes Daniell and Sara S. Hamilton. John Wiley & Sons, 2010, pages 206-208.