Financial Planning can seem like such a daunting task. But it is a vital step to help you secure your future. Financial Planning Pyramid is an easy and useful tool that helps you do that. This plan is adaptable to your lifestyle. This type of planning helps you build a solid foundation and overcome uncertainties. As per Maslow’s theory, you have to meet your basic needs before meeting your higher-level needs. This pyramid helps you achieve that, and this article shows you how.
The primary rule for this financial plan is to first build a solid and sturdy foundation and slowly work your way up. Attempting to address all stages at once will do more harm than good. The base of Financial Planning Pyramid is protection, the middle is the accumulation, and the pyramid’s tip is distribution.
Protection Of Wealth
Wealth Protection is the base of the financial planning pyramid. It says to protect what you have.
It can be seen that investing and building assets is all that is needed for financial growth. That is far from the truth; covering your risks and protecting your welfare is an equally more important step. The most critical step of your financial planning journey is the protection stage. This stage provides you with a cushion in case of any ill-fated emergency.
This stage makes you face reality and ask yourself some tough but important questions like:
- In the event of death, sickness, accidents, etc. is your family equipped to take care of themselves?
- In the event of unemployment, do you have enough funds to secure your future?
This step includes different insurances but is not limited to these.
i. Health Insurance–
Health is wealth. Getting health insurance is a crucial step in this plan. It provides you with a financial backup in times of health crisis. Health insurance can also add an income tax benefit. Buying insurance for your family is necessary even if your job offers medical cover. This will protect your family’s health even if you leave your job or get fired from your workplace.
ii. Life Insurance-
The majority of people in India see life insurance as a preferred investment option right after fixed deposits. Whether you see it as an investment option or fall-back plan for your family, this insurance is vital. Life insurance will help you guarantee the future of your loved ones. It ensures that if the breadwinner dies, the family does not have to rely on others for their needs. Also, this insurance has tax benefits and long- term capital appreciation.
iii. Disability Insurance–
Disability insurance is a preventive measure that one takes to ensure their livelihood. This insurance helps you cover all your bases. If one is physically unable to work, their income reduces. The purpose of this insurance is to provide money to pay your expenses that you earlier would have been able to.
iv. Homeowner’s Insurance–
Homeowner’s insurance will safeguard your house against tragedies like fire or vandalism. Some insurances even insure your possessions. This insurance is relatively inexpensive and can prove of great help in the future.
There exist a million other insurances in the market, that does not mean you should buy every one of them. But instead, those insurances that help you reach your goals and can assist in creating wealth.
Positive Cash Flow
A very important step of forming this solid foundation is to ensure that you have a positive cash flow. The number one thing you must ensure is that your income exceeds your expenses. Having a positive cash flow includes forming a budget and cutting some expenses. Spending your money carefully and avoiding late fees are some more examples. Finding ways to increase your income is also a part of this. The most important thing about forming a positive cash flow is sticking to it. An honest review of your expenses helps you understand where you currently are and where you want to be. It helps you stay motivated and helps you gauge how much you need to cut down or save.
Accumulation Of Wealth
Wealth creation comes in the middle of financial planning pyramid. Once you have built a strong foundation, you can start investing and building your assets.
To invest, you must save. To do this, the first step is to open a savings account. By transferring a part of your salary to this account, you’ll be able to save without any problem. Having this automatically transferred to your savings account is usually the best way. The amount you save will completely depend on you, your lifestyle, and your income. The amount you’re saving is not very important, but starting early is. Starting early allows your funds time to compound, which will help them to grow.
ii. Debt Reduction
By paying off your loans early, you are eliminating interest charging liabilities. This is an investment since instead of gaining assets, you’re reducing liabilities.
Your ultimate goal must be to pay off your debt, rather than reducing it completely. It is important to come up with debt- reduction strategies that help you. Some people choose to pay off one debt entirely and then go to the other, while some choose to pay altogether. Some investors recommend paying off your debts and then investing. Some say, juggle both together. But one thing everyone must do is look for more ways to put money towards debt- reduction.
An important part of debt reduction is creating an emergency savings fund. This should usually comprise of 3-6 months’ worth of your salary. This is an amount you can cash-in, in case of an emergency.
iii. Financial Goals
Before investing, you must make a list of realistic financial goals that you want to achieve. These can be a retirement fund, your children’s education or purchasing property, etc.
Some even save to start a business. Some save for their dream holiday. What you wish to save for depends completely on your dreams and expectations.
Now comes the exciting part, Investing! Keeping your money locked up in saving accounts will make inflation eat it up. Without investing it, your money will soon lose its purchasing power.
One should select suitable investment options based on their income and convenience. Conservative investors would choose to invest in safer options. At the same time, aggressive investors have entirely different strategies. How you choose to invest depends on how much money you have, your knowledge, and your comfort level with risk. Your asset allocation should suit your risk appetite.
One should never put all their eggs in one basket and always work towards diversifying your portfolio. Blue-chip shares, long-term mutual funds, and bonds are some high-quality assets. Some popular investment options are Public Provident Fund, Fixed Deposits, RBI Taxable Bonds. Real Estate and Gold are also seen as good investment options.
Mutual funds are often considered to be a reliable and secure investment option. This is partly because professionals handle the money. But one can’t turn a blind eye after investing in mutual funds. It is very important to check-in and brings change to your asset allocation.
Speculation is also considered a wealth accumulation tactic. Speculation is buying shares with the purpose of selling them very soon.
It is advisable to only partake in it after taking care of insurances, savings, and investment. Speculation can lead to total losses or gains. Thus, it important to speculate with money that you are comfortable with losing.
The common mistake that people make is to speculate with a huge amount. Speculating, before taking care of investments is another common blunder.
Distribution Of Wealth
Wealth Distribution is on the top of financial planning pyramid. This stage includes the gratifying task of passing on your hard work to whoever you want to.
Estate Planning deals with the allotment of assets after their death. It includes writing out a Will, or even forming a Trust, if applicable. This is usually left till retirement; thus, a problem arises in the event of early death.
A basic wealth distribution plan should include a Will that describes their wishes. It should state what will happen with the assets, whether the heir will inherit it or family members. The Will can also convey if a charity receives all the assets. If the deceased owned a business, there should be a proper succession plan set in the case. A Will can also state who will be your Power of Attorney and Healthcare Proxy.
Tax planning should be a part of every step of the financial planning pyramid. The higher you reach towards the pyramid in the upward direction, the greater your risk. Taxes can affect all your activities, like your insurances or your investments.
If you do not have enough knowledge of filling your taxes, seek professional help. But be cautious, because by doing so, you’re allowing brokers and agents to take control of your finances. They might offer to fill forms without your presence or offer market returns that seem too good to be true. It is very important to wary of such people.
If you are filling for your taxes, it can help to plan your tax-saving investments at the beginning of the year. This allows you to maximize your deduction under various plans. Go through all your exemptions and deductions besides the most common, Section 80C. If you have health insurance, read Section 80D. If you have made donations to charities, read Section 80G. By not being aware of tax deductions, you are incurring losses that could have been your gains.
Frequently Asked Questions
1. I have recently started reading about the financial planning pyramid method. But how should I apply what I’ve learnt?
The recommended method is, writing down your insurance, assets etc
Then compare which stage you are on. See if you have covered the base stage before climbing up.
2. What type of life insurance would be ideal for me?
Term life insurance is usually the most sought after life insurance. It fulfils the most basic reason that one gets it, it pays the people you care about after you die.
3. How does one get a disability insurance?
Disability insurance is often an added benefit rider that you can attach to life insurance. To do so, the policyholder may have to pay a small fee. One can also contact their insurance agents and get a separate disability insurance.
4. Why is homeowner’s insurance important?
Homeowner’s insurance insures your house against disasters like fires, earthquakes etc.
One also has the ability to protect their possessions with this insurance.
5. How much should I be saving?
There is no fixed amount that anyone should be saving. It varies with age, income and goals. 10% of your income is considered a good start. But it that is too much or too less, you can always adjust it.
6. How do I decide what my asset allocation should be?
Your asset allocation should be where you are comfortable and within reach of your goals. The answer to the question, “where shouldone invest their money?’ relies on you and your family’s goals. In this regard consider your timeline, goals and risk tolerance.
The more time you have, the riskier and more reward opportunities you have. Your asset allocation must be flexible and change as you reach closer to your financial goal.
If your current asset allocation keeps you up at night, it is likely that you have not invested correctly.
7. How much should I save for retirement?
The answer to this question is different for everyone. To estimate an amount required, you need to decide what your ideal retirement is like. One should ask important questions like, where will I live? Will I keep my current level of spending and living? Do I want to change their lifestyle? How is my health? Do I want to travel?
8. What are the usual components of a Will?
A Will must include-
i. a legal heir for your children
ii. distribution of your property
iii. someone who will execute your will
9. How will inflation affect your savings and how to avoid it?
Inflation tends to reduce the value of one’s savings over a period of time. Say, the rate of inflation is 6% for a year. So, the value of say a sum of 100 rupees will reduce to 94 rupees over a year.
Investing in Real Estate and Gold is your best shot to beat inflation. Some insurance firms also have schemes which will protect you against it.
While attempting to plan your finances, you might fail, fall and feel like giving up. But remember that the financial planning pyramid process is a dynamic process. It’s not a time activity.
As we go up the financial planning pyramid, the risk increases and liquidity decreases. The bottom layers ensure financial security and upper layers ensure financial success.
This article has all the information you would need to start planning your finances. The beauty of this planning system is that it allows you to customise it your needs and wants.