Every investor aspire for creating enough wealth that will help sustain the lifestyle for longer period and ensure safety against future uncertainty. This objective is achieved through a systematic investment process which leads to “wealth creation”. It is a process of accumulating assets (especially those that generate income) over a long period of time. Your wealth could be in the form of property, deposits, gold, shares and other such assets.
It is important to understand the basic steps for wealth creation. There are three basic steps to accumulate wealth over time, they are: make money, save money and invest money.
Of the three the most important is to make or earn money, which will be a long-term source of income sufficient to have some left after you’ve covered your necessities and debts.
Once income generated enough to cover basics need, it is absolutely necessary to develop a proactive savings plan and invest it prudently.
The above three steps clearly underline the fact that it takes money to make money; just as it takes wheat to grow wheat. A healthy savings rate is the basis for creating wealth. Well, it simply is the rate that enables to achieve financial goals, given the investment temperament and preferences.
Since many of us face the issue of having limited wealth, we need to prioritize our needs in order to ensure that we use this resource in the most optimal manner to fulfill the most important needs or goals.
Typically, all the money that is surplus to you at the present moment could make up your wealth. It may of course be needed in future to meet your financial commitment. Your wealth could be in the form of property, deposits, gold, shares and other such assets.
The amount of gross wealth that you can potentially build up in your lifetime (ignoring the utilization on financial goals for the sake of simplicity) typically depends on savings, return on savings and the time given for savings to grow.
A healthy savings rate is the basis for creating wealth. This could of course raise the question as to what a healthy savings rate actually is. Well, it simply is the rate that enables you to achieve your financial goals, given your investment temperament and preferences. Remember, it is your savings and not gross income that makes you wealthy.
It is quite obvious that higher the return that your investment earns more is the wealth that you are going to create for yourself. Your investments have to earn a return which is enough to meet your financial commitments.
At a very basic level, your post tax investment return should at least match the inflation levels just to stay afloat. If the return falls below the prevailing inflation level, your wealth would be eroded or destroyed. The purchasing power of your wealth weakens gradually over time if it underperforms the inflation level. So, inflation would be the floor level that your wealth would have to earn post-tax over time, just to stay where it is in terms of relative value.
Finally, your risk profile will determine a suitable investment product. If the gap between your present and future is large, you may need to take on quite a bit of risk with your investments in the hope that the potentially higher returns would help you bridge the gap. Let say, if you have a large amount of loan to repay or your primary, earned income itself is too unstable or uncertain. In this case you may not be able to expose your investments to a high degree of risk.
Your risk profile is only one part of your investment puzzle. The other part is about financial prudence. Even if you have the requisite risk profile, it is not wise to put all your money in one risky asset.
Different asset classes perform differently across time periods.
Your portfolio downside would be limited as a chance of all assets declining simultaneously is remote.
Return should always be measured through the prism of risk taken.
A prudent asset allocation pattern that takes care of your risk profile and return requirements could be the secret of your success. You need to allocate your investments among the various assets according to this pattern and more importantly rebalance back to the original allocation periodically. As different assets perform differently during any given time period, your allocation is likely to get skewed towards the strong performer which increases the risk of your portfolio.
High earnings alone cannot make one wealthy. It is the discipline and financial prudence in utilizing those earnings which are the true determinants of wealth
Finally, it is the ability to create a healthy and sustainable economic profit over and above all costs, including the cost of capital, and to continually reinvest and grow those economic profits over time is what truly unlocks the potential for enduring wealth creation. It is when those characteristics are present and married to a longer-term time horizon that the magic of compounding occurs.
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