3 critical steps to building your financial pyramid

Personal financial planning is about connecting various dots in our financial life. The word financial planning invokes a whole range of thoughts. A majority of these thoughts are about investments and the returns we expect from these investments. However, in this process of overemphasizing on the returns and investments, we often fail to follow prudent and methodical ways of building our personal financial plan.

Building a financial pyramid is a great way of ensuring a solid foundation for our financial life to reap long-term and better benefits. The various stages of building a financial pyramid, their importance and governing factors are stated below.

Step 1: Risk management
A pyramid, which is considered as one of the strongest structures, gets its strength from its base. Similarly, risk management should fill this space and form the base of one's financial pyramid. A perfect financial plan should concentrate on countering the unexpected risks or emergencies of life. The most common emergencies we experience in life are job loss, health scare or risk of life. If one does not take measures to counter these risks, they have to fund such emergencies using the wealth they have accumulated. We generally accumulate wealth to ensure that we achieve our financial goals. Lack of efficient risk management techniques would have a negative impact on our ability to achieve the goals we set for ourselves. As a first step, one has to ensure that they have a healthy emergency fund, adequate life insurance cover and medical insurance cover. During this process, it is important that we analyze our past financial decisions like existing insurance policies, liquid and illiquid assets we hold.

Step 2: Wealth protection and wealth builder
The second stage of building a financial plan should concentrate on building a road map for turning our dreams into reality, or goal planning. The investments should always be aligned with our goals. We have to strike a balance between the risk and reward of the investment choices being made by us. The investment planning should be in sync with the risk profile of the individual and the tenure of the goals we are set to achieve. Balancing the risk and reward would require us to define a well-diversified portfolio. One should avoid over exposure to single asset class. One has to be realistic while setting the goals and relevant expected returns from the investments being made to achieve the goals. It is often a recommended practice to opt for monthly investments. It induces the necessary financial discipline in one's life.

Step 3: Wealth multiplier
Wealth multiplier is the final stage of building a financial pyramid. This is the stage at which one can take higher risks when it comes to making investments. Ideally, by the time one reaches this stage, the risk against uncertain events is managed, monthly savings are being made towards achieving their goals and yet have additional surplus. Higher the risk associated with the investment, higher the probability of incurring loses. Since these high-risk investments are made only after taking care of risk management and goals, any potential loss in such investments would not impact our ability to achieve our goals.

ArthaYantra is an integrated online personal finance company.

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