While we all know that we need to save, buy insurance, save taxes, and invest, most are unaware of where and how to start. Setting your priorities go a long way in achieving goals, and this is where a personal finance pyramid can help you. So, what is it, and what are its components? Let’s find out.
A personal finance pyramid is an approach towards better managing your finances in order of importance. The basic rule is to start from the bottom and move towards the top and not attempt to address all aspects at once.
Life is unpredictable, and a disaster can strike at any moment. Financial prudence calls for being prepared for the worst; hence, protection forms the base of the pyramid. Life and health insurance provide the much-needed financial backup in the event of a mishap. While life insurance gives you peace of mind that your loved ones would not be in a lurch in your absence, health insurance prevents out-of-pocket expenses in the event of hospitalization.
Equally essential is to ensure that the coverage of all insurance plans are adequate. As per a popular thumb rule, your life insurance coverage should be equivalent to at least ten times your current annual income. If you live in a metro city, your health insurance coverage should be at least Rs. 10 lakhs as medical costs in metros are higher than in non-metros. Compare plans and choose the one that best fits your needs.
Emergencies often arrive unannounced and can derail even the soundest financial plans. Savings for future goals and emergencies form the next part of the pyramid. Covid has shown the need to save for rainy days, and ideally your contingency fund should be worth one year of expenses. You can build this fund through disciplined and sustained investments in liquid funds that offer slightly higher returns than a savings account.
Even after you have built an adequate emergency fund, you shouldn’t stop. Increase the percentage of savings each month with an increase in income. Follow the SLR (safety, liquidity, and return) principle while building the emergency fund. Invest in instruments that allow you easy access to money when required.
While disciplined savings form the backbone of a sound financial strategy, it may not be enough for you to meet your financial goals due to factors like inflation. Therefore, you need to invest your savings systematically to grow your wealth. The objective should be to align your investments with your goals and risk appetite and invest in inflation-beating asset classes.
This is where investment in equities can help you, as equities can potentially deliver inflation-indexed returns in the long run. Figure this. Even a modest SIP of Rs. 5000 in an equity mutual fund offering annualized returns of 10% for a period of 20 years can help you amass a corpus of above Rs. 37 lakhs.
Investment in a mix of market-linked and fixed income products can help you build wealth for future goals with ease.
Estate planning is often the most overlooked aspect of financial planning and management. While most of us take multiple steps to secure our financial future, we miss out on being proactive in passing on our financial legacy. As per estimates, over Rs. 51,500 crores is lying unclaimed with financial institutions like banks, insurance companies, and mutual fund houses. This is because customers fail to allocate nominees, as a result of which next of kin are deprived of deserving wealth.
As such, ensure you assign nominees to all your savings accounts, investments, provident fund account and insurance purchases. Apart from that (assigning nominees), keep trusted family members in the loop about all your finances (investments, insurance) and timely create a Will detailing passing on of your assets. Also, make it a point to get the Will registered to avoid any confusion later.
Source: Jagran