Regarding personal finance, we all know that we should save, buy insurance products, save tax and invest. However, most people are unsure where to start. Setting priorities helps a lot in achieving goals. Here you can get help from the Personal Finance Pyramid. Come, let us know what it is and what are its main components. Let's find out.
What is the Personal Finance Pyramid?
The Personal Finance Pyramid is an approach to better manage finances based on importance. Its most basic rule is to start from the very bottom and move upwards. At the same time, one should not try to address all aspects simultaneously.
Protection: Base of the Pyramid
It cannot be predicted what will happen in life. Any disaster can occur at any moment. Financially, it is wise to be prepared for bad times. In this way, protection comes first in the security pyramid. Life insurance and health insurance provide the necessary financial backup in case of an accident. Life insurance gives you peace of mind that your loved ones will not falter in your absence. At the same time, with health insurance, there is no out-of-pocket expense in case of hospitalization.
Along with this, it is equally important to ensure that the coverage of all insurance plans is adequate. A popular rule of thumb is that your life insurance coverage should be ten times your current annual income. If you live in a metro city then you should have health insurance of at least Rs 10 lakh. This is because medical expenses are higher in metro cities than in non-metro cities. Compare all the plans and choose the one that best suits your needs.
Saving for future goals and emergencies
Emergencies can arise at any time and can derail even a strong financial plan. Saving for future goals and emergencies comes second in this pyramid. Covid has highlighted the importance of saving for tough times and ideally, you should have at least a year's emergency fund. These funds can be created through disciplined and consistent investments in liquid funds that offer returns slightly higher than a savings account.
You should not stop even after preparing an adequate emergency fund. Increase savings every month as income increases. The SLR (Safety, Liquidity and Returns) principle should be followed while creating an emergency fund. Invest in such instruments in which you can easily get money when needed.
Investing to create wealth
While saving in a disciplined manner is the backbone of a strong financial strategy, due to inflation it may not prove to be effective in achieving financial goals. Therefore, to increase your wealth, you need to invest your saved amount systematically. Here your investments should be made in a way that meets your goals and risk appetite. Along with this, the investment you make should be in such a fund which has the power to beat the inflation rate.
Investing in equity helps here as equities have the potential to give higher returns than the inflation rate index in the long run. Consider this. Even by investing Rs 5,000 every month in an equity mutual fund giving a 10 per cent annual return, you can create a corpus of Rs 37 lakh in 20 years.
By investing in market-linked and fixed-income products, you can easily create wealth for future goals.
Estate planning for inheritance
People often ignore estate planning while creating and managing their finances. While most of us take various steps to secure our financial future, we are not able to think proactively about handing over our financial legacy to someone else. According to an estimate, an amount of Rs 51,500 crore is lying with banks, insurance companies and mutual fund houses, and there is no one to claim that. The reason for this is that people forget to make nominees. Due to this, the loved ones of the deceased are not able to get the money.
In such circumstances, you should make a nominee on all your savings accounts, investments, provident fund accounts and purchase of insurance. Along with this, you should give information about your investments and insurance to trusted members of your household. Additionally, prepare a detailed will regarding how your assets will be distributed in your demise. To avoid any confusion later, do not forget to register your will.
