Things you should know before investing Part III: The right way to create an investment plan

This post is in continuation and is third in the series to the following earlier posts on “things to remember while investing”

Understanding asset classes

Risk profile, Asset Selection and Allocation, Portfolio re-balancing

Today I touch upon an investing approach that is not present in any financial planning text-book but in my personal opinion, is critical to the success of any financial planning….

 Story of a couple

Let us see a story of a Mumbai couple Ramesh 30 year old salaried person, and his wife Smita. The couple also have a 2-year old daughter.

They have purchased sufficient term insurance, but don’t have medical insurance nor have made any sort of contingency fund.

As any well-intentioned parent, they was concerned about the rising costs of education and wanted to plan for the daughter’s college expenses. So, they started a SIP in a good equity mutual fund of Rs. 5,000/- per month to plan for this goal.

A year down the line, the market was bearish and fund value of their investment stood at Rs. 50K. Though slightly disappointed with the short-term fund performance, they were at least happy that they were doing something to plan for their daughter’s education…

But just when everything was going so well, Ramesh met with a severe accident on his way to office and got hospitalised. The medical bill came to Rs. 2 lacs. It was then that the family realised the importance of having a sufficient medical insurance and contingency fund.

Because they didn’t have any, result is not very difficult to imagine – they had to liquidate their mutual fund investment, and for the remaining amount, fund it through credit card and borrowing from near relatives…..

Not a pretty situation isn’t it?…

What started out as a good and well-intentioned long-term investment plan ended in a “debt trap” for the family…But this is a smaller loss – the bigger loss is the loss of faith and confidence in following a planned approach to achieve financial goals…

The mistake?…they did not follow what I call the “pyramid approach” while making their investment plan!

 Typical financial characteristics of a young family

Now-a-days, every young family has following commonly characteristics:

  1. Risks like death, hospitalisation, etc.
  2. Certain set financial goals that it would want to plan for. The financial goals can further be broken down into following:
  • Short term goals like raising funds for down payment of flat, or preparing a corpus for delivery and new-born  baby – these goals which become due in short period of time say within next 5 years
  • Long term goals like child education, retirement etc. – these are goals that are quite far away – say more than 5 years…
  • Loans – home loan, car loan, personal loan, credit card outstanding…..

 What is the “Pyramid approach” to investing?

 Consider that you are building a multi-storey building….What will you do first – Build the top floor or a lay a strong foundation?

 Check out the image below to get some idea:

 investing pyramid

Remember, without a strong foundation, if you try to create a building, it has a great chance of falling down….same goes true for any financial planning!


First step: “Risk Planning”

The foundation for any good and sustainable investment plan is proper “risk planning”.  Only after this foundation is created should you go ahead to plan your financial goals.

How do you do “risk planning” – by taking proper insurance covers + building a reasonable contingency fund.

I have written on this blog on various types of insurances  and how to build a contingency fund, please check out the same.

One question you may ask – “I do not have any contingency fund or insurance covers – I might have to wait for 2-3 years to create the same? Do you mean to say I should not start planning for my goals?

My answer will be – YES. Treat creation of “contingency fund” and getting necessary insurance covers as your ONLY FINANCIAL GOAL for the time being. Your salary/ income will not remain constant all through your working life. As you achieve this goal, you will be able to plan for short term and long term financial goals…so chill!


Second step – Plan for “Short term goals”

Now, after the foundation is created, one should first look at planning for short term financial goals.

You should analyse the monthly cash flow pattern and whatever the surplus is there, create a systematic plan for short term goals.

As part of the conversations we have with our financial planning clients, the dilemma that many couples face is that there are multiple financial goals and a limited amount of surplus to invest (this generally is because of the couple has a home loan and after EMI, nothing much is left). What to do in such a case?

My answer – As per the pyramid approach, take up and plan the short term goals first and don’t fret over long term financial goals.  Why?

 Because if you don’t plan for short term goals, when it becomes due, you will unnecessarily fund it either of 2 ways:

  • Taking up a loan – this can potentially create another debt trap for you and further de-stabalise your financial situation…
  • Liquidate funds set aside for long term investments – since you have to do it whatever be the market levels, apart from risk of liquidating at a loss, you will be de-railing your long term financial plans…

 Third step – Plan for “Long term goals”

 Now that short term goals are planned out, and with passage of time and increase in your salary/ income levels, you should start to plan for long term financial goals. 


With existing home loan EMIs, there is not much left for planning long term goals. Is it a better idea that instead of planning for long term goals, isn’t it a better idea to save and pre-pay the loan?

My view:

NO. When you pay home loan EMI, you are in a way investing in a single asset class. Again, when you pre-pay the loan, you create a “heavyweight exposure” in a single asset class – this is against the principles of asset allocation. Instead, you should continue paying your EMIs but do plan for long term goals simultaneously –  this way, when you invest in mutual funds, PPF and gold, you take exposure to those asset classes as well, and also get benefit of compounding to grow your corpus quickly.

Hope this post was useful to you and provides you some direction on the right approach for creating an investment plan for your financial goals. In the next post which will be the final part of this series, we will analyse a case study to plan their financial goals.

Do put in your thoughts in “comments” section…