Financial Planning Pyramid — A Primer

We have a multitude of financial goals — but don’t know how to prioritise across these goals. Should one focus on investing in stocks or get insurance first. How does one split investments across different financial goals? And so on. Enter the financial planning pyramid — a nifty tool for a big picture approach to financial planning.

Here’s a simplified financial pyramid (on the left) — mapped to the relevant financial products (on the right). Let’s understand the pyramid better.

The construction of a pyramid starts at the bottom with the large base providing stability to the structure on top. Good financial planning follows the same approach. It helps you decide which financial matters should be addressed first. You need to progress from the bottom — upwards.

1 — Protection Stage

The first step of financial planning should ensure that you have sufficient protection for any urgent or unplanned expenses. For example, your dear ones might need to be hospitalised for an illness and good medical care is expensive. You will have to pay money up front for hospitalisation and then some for the treatment. You will need access to liquid cash and health insurance to cover for these expenses. Withdrawing investments in mutual funds/FDs etc. can be an expensive affair if the timing is against you. We recommend the following plan of action in order:

  1. Maintain 3 to 6 months of your salary as cash in your bank account or liquid investments so that it can be withdrawn at a moment’s notice.
  2. Get adequate life insurance.
  3. Get adequate health and disability insurance.
  4. Cover for any other relevant risks as they arise — e.g. travel insurance when traveling abroad.

Protection related needs should be taken care of first, before moving to the next financial stage.

2 — Life Goals Based Savings Stage

At this stage you need to look at your goals in life and start investing towards those. Financial goals can be broadly split up into short, medium and long term goals depending on the time left to achieve them. Typically — goals due within 3 years can be called short term goals. Goals due between 3 to 10 years are called medium term goals and those due beyond 10 years are called long term goals. Your investments options are defined by the specific goals you want to achieve. E.g. Mutual funds are better suited for achievement of long term goals while FDs are better for achievement of short term goals. This is the recommended plan of action:

  1. Define your life goals (e.g. higher education, purchase of a house, retirement savings etc.). Even if you don’t know all of them make some broad assumptions.
  2. Start investing towards each of those goals based on its priority.
  3. Closely monitor your goal specific investments and make adjustments when needed.

3 — Wealth Creation Stage

Once you have taken care of the previous two stages — you should consider investing with the objective of creating wealth. Since your life goals are taken care of through the investments in the first 2 stages — you can afford to take more risks with the hopes of a higher return.

For such investments, you could choose to invest directly in individual stocks or trade in forex markets or even cryptocurrencies. Or maybe get into venture capital or invest in a hedge fund. There are a multitude of options for the savvy investor. Caveat emptor — all such investments intrinsically have high risks commensurate with their promises for high returns.

Did this simplified approach to investing make sense to you? We’d be really happy if you can clap to show your appreciation or share it with your friends who might find this useful too.