In Part 1, How to Create Wealth? A DIY Series to Learn Wealth Creation Basics- Part 1 we started this marathon of How to Creating Wealth By Doing-It-Yourself way, by learning the starting point- The Net Worth Calculation. In Part 2, How to Create Wealth? A DIY Series to Learn Wealth Creation Basics- Part 2 we went a step further a learned Budgeting. Budgeting helped us know what is our disposal income and how to know what we can save?
Part 3 takes you one more step ahead, which is Investing the Savings. You have budgeted and identified an amount to save monthly.
Where are you going to put your savings? By investing, you put the money you save to work making more money and increasing your wealth. An investment is anything you acquire for future income or benefit. Investments increase by generating income (interest or dividends) or by growing (appreciating) in value. Income earned from your investments and any appreciation in the value of your investments increase your wealth.
There is an art to choosing ways to invest your savings. Good investments will make money; bad investments will cost money. Do your homework. Gather as much information as you can. Seek advice from personnel at your bank or other trained financial experts. Read newspapers, magazines and other publications. Identify credible information sources on the Internet.
Some facts to know before you start investing
- Compound interest helps you build wealth faster. Interest is paid on previously earned interest as well as on the original deposit or investment. For example, Rs 5,000 deposited in a bank at 6 percent interest for a year earns Rs 308 if the interest is compounded monthly. In just 5 years, the Rs 5,000 will grow to Rs 6,744.
- Time horizon -How long can you leave your money invested? If you will need your money in one year, you may want to take less risk than you would if you won’t need your money for 20 years.
Rule of 72: We wrote about About Rule of 72 in detail here – Simplifying the Rule of 72
- Inflation is that kills your wealth silently. Thank god the extent of kill can be limited by earning more than the rate of inflation. While investing you should focus on Real Returns and not the Nominal Returns.
- Financial goals – How much money do you want to accumulate over a certain period of time? Your Investment decisions should reflect your wealth-creation goals. We wrote about Goals in Detail Here.
- The Risk-Return Relationship– When you are saving and investing, the amount of expected return is based on the amount of risk you take with your money. Generally, the higher the risk of losing money, the higher the expected return. For less risk, an investor will expect a smaller return.
For example, a savings account at a financial institution is fully insured by the Deposit and Credit Guarantee Corporation (RBI Subsidiary) up to Rs 100,000. The return—or interest paid on your savings—will generally be less than the expected return on other types of investments.
On the other hand, an investment in a stock or bond is not insured. The money you invest may be lost or the value reduced if the investment doesn’t perform as expected.
After deciding how much risk you are able to take, you can use the investment pyramid to help balance your savings and investments. You should move up the pyramid only after you have built a strong foundation.
Tools for Savings
Once you have a good savings foundation, you may want to diversify your assets among different types of investments. Diversification can help smooth out potential ups and downs of your investment returns. Investing is not a get-rich-quick scheme. Smart investors take a long-term view, putting money into investments regularly and keeping it invested for five, 10, 15, 20 or more years.
You can invest in many assets like Shares, Mutual Funds, Commodities, Fixed Deposits, Government Securities, Bonds, Gold, Real Estate and many derivatives of these broad categories.
The ground rule is to understand your needs, your risk profile makes a portfolio in line with your goals, by minimizing risk through proper diversification as per the asset allocation. Than Reviewing the portfolio to match asset allocation and incorporate changes.
Historically this has been the picture:
As mentioned, the picture is not to advocate investing in equities. You need to take a scientific approach to investments which is Financial Planning.
With this, we end the part 3. In the next part, we will learn about Debt, its forms, its problems and controlling debt.
Please share your comments below and your views on Wealth Creation.
