My friend Anil hails from a small town. His father was a Government servant and his mother was a housewife. His parents fulfilled all his needs but there was never a situation of surplus and Anil grew up with a strong desire to be richer and more successful. He was hardworking and honest. Anil completed his education from a premier college and within a few years was working at a senior level in his organisation. He was also earning well and was living an aspirational lifestyle. However in spite of having worked for so many years, he still did not have any assets, was saddled with multiple EMIs and was always short on free cash. He recently met with a serious accident and had to stay off work for almost six months. While he continued to remain employed, he did not receive a salary for those many months. While his employer’s group health policy helped him cover some of the expenses, he ended up borrowing money from close friends and had to mortgage his wife’s jewellery to pay for all other incidental costs, regular expenses and EMIs. While his health gradually improved, his financial health needed surgery.
Do some aspects of this story sound familiar? Most of us grow-up financially ill-literate disorganised even though chances are that if you are reading this article, you are a well-educated person. While there is no dearth of investment avenues, we still fail to plan for life’s contingencies, risking that extra cash we have stashed away for rainy days. As an insurance professional with two decades of experience, I have been thinking about a simple framework that can help us plan for our future from a financial perspective.
Recently, I found inspiration in Maslow’s theory on the hierarchy of human needs. Abraham Maslow published a paper on “A Theory of Human Motivation” in the year 1943. The most important aspect of Maslow’s theory of human motivation is the “hierarchy of needs.” This categorizes the human needs in the form of a 5-level pyramid where the base of the pyramid represents the most basic “Physical Needs” and moves up to “Safety”, “Love/Belonging”, “Self Esteem” and finally the need for “Self-Actualization”, which forms the top of the pyramid. Applying this theory, here’s my proprietary 4-level model, which can help answer the questions of “where to invest” & “what to invest in”.
The first level of financial planning hierarchy constitutes “Family Protection” and must comprise of, in order of priority, a Contingency fund for 6 months’ expenses, a Health Insurance Plan and a Term Life Insurance Plan. Let us look at the options for Level 1 needs here. There are various types of health insurance plans –Hospitalisation reimbursement or commonly known as a medi-claim plan, which covers the cost of any kind of hospitalisation. Critical Illness plans provide a fixed amount upon diagnoses of specified illnesses. The amount provided by critical illness plans complement the hospitalisation cover and provide an additional cushion of safety.
Term plans are the cheapest forms of Life Insurance cover available and one should build adequate corpus/sum assured through term plans before delving into other investments. One should look at term plans with the maturity age of about 65-70 years. There are new-age term plans which cover for whole life i.e. age 99 years and can be used as low-cost instruments for creating a legacy.
Level 2 in the financial planning hierarchy comprises “Life Goals” like buying a house, paying for child(ren)’s education, marriage etc. This can be accomplished by a judicious mix of goal-based investments in Mutual Funds, ULIP plans, traditional banking instruments like FDs/RDs, other traditional insurance plans and Gold/Jewellery, etc. Direct investment in equities must be avoided by those who do not fully understand the subject well. ULIP plans, certain Mutual Funds and Bank FDs also offer tax advantages. ULIP plans are long term instruments that offer a unique combination of Savings and Life insurance protection.
The 3rd level in the financial planning hierarchy is planning for “Retirement”. This comprises two distinct phases - “The Accumulation Phase” in which one gradually builds a retirement kitty during financially productive years and secondly the “Draw-down phase” during which the corpus built in the accumulation phase is used to provide systematic income during post-retirement years. For the accumulation phase, there are multiple avenues like Employees Provident Fund (EPF), National Pension Scheme (NPS), Mutual Funds, ULIPS and other traditional insurance plans.
For the draw-down phase, Life Insurers offer unique products called Annuities, which provide a steady income stream for life upon payment of a single one-time premium.
The final level in the financial needs hierarchy is planning to leave a “Legacy” for your loved ones. This can be done through Long Term Savings or Legacy Plans – While this could be the last area of financial focus, in some sense this must be done gradually over the years, by carefully building long term assets throughout ones’ earning life. Life insurers offer Whole Life Term Plans up-to 99 years of age, which are one of the most efficient and cheapest means of leaving a legacy for children as compared to any other assets. The Whole Life Term plans can serve the dual purpose of “Family Protection”in the early years and creating “Legacy” in later years.
The order suggested here would apply to most of us, however, will need to be altered depending on your current financial situation and life-stage. Having understood all these levels of financial needs hierarchy, one can create a plan and seek the advice of professional financial planners as needed, to help carefully select the right products and instruments.
(The writer is Head Products, PNB MetLife India)