Four Pillars for a Strong Financial Foundation

Investing for your financial goals is not just about choosing the right investment or earning the highest return possible. It is about building a well-rounded and strong financial foundation.

A strong financial foundation helps you invest with greater confidence, remain disciplined and avoid disturbing long-term investments when unforeseen expenses arise.

There are four important pillars that support this foundation.

1. Life Insurance

The first pillar is adequate life insurance.

If there is an earning member in the family, his or her income supports several financial responsibilities, including household expenses, children’s education, loan repayments and future goals.

An unfortunate death can therefore create not only an emotional loss but also a significant financial loss for the family.

A suitable life insurance cover, preferably through a term insurance plan, can help replace this lost income and provide financial security to the dependants.

Life insurance is therefore primarily about protection against the financial impact of losing an earning member.

2. Health Insurance

The second pillar is health insurance.

Hospitalisation is unpredictable. A major medical emergency can arise suddenly and potentially consume a sizeable portion of a family’s savings.

Having adequate health insurance ensures that an unexpected hospitalisation does not force you to withdraw money from investments created for other financial goals.

Your savings and investments can then continue doing the job they were originally meant to do.

It is important to have comprehensive personal health insurance with the necessary product features rather than depending entirely on your employer’s health insurance.

3. Contingency Fund

The third pillar is an emergency or contingency fund.

Ideally, a family should keep approximately six to twelve months of household expenses plus EMIs in a highly liquid and conservative avenue such as a bank account, fixed deposit or suitable debt mutual fund, where capital safety and liquidity remain the priority.

Think of this as your financial piggy bank, money that is kept aside specifically for emergencies.

Knowing that this reserve exists can give you the confidence to invest the rest of your money with a longer-term perspective, without constantly worrying about short-term emergencies.

4. Asset Allocation

The fourth pillar is proper asset allocation.

Every financial goal has a different time horizon. Some money may be required within a few years, while other investments may be meant for goals several years or decades away.

The investment product chosen must therefore match the time available for the goal.

A mismatch between the investment and the time horizon can create unnecessary complications in the portfolio.

In simple terms, short-term goals should generally be invested in assets that offer a greater degree of capital safety and liquidity, such as bank FDs, RDs or debt mutual funds.

Long-term goals, on the other hand, need exposure to assets that have the potential to beat inflation and create wealth over time, such as stocks, equity mutual funds, hybrid mutual funds and gold.

(The writer is a Chartered Accountant and CFA (USA). Financial Advisor. Views are personal. He could be reached on 9833133605.)