Essential Wealth Creation Principles
There are many strategies, philosophies and ideas on investimg though these are essential wealth creation principles. Whether it’s day trading shares, currencies, property portfolios, cryptocurrency or the Warren Buffet way they all have their specific hooks. Some have more merits than others whilst others are completely unrealistic for your average investor. For example, you can’t achieve Warren Buffet’s growth because you don’t have interest free leverage from insurance companies like him. We’re not knocking Mr. Buffet on the contrary we’re actually big fans.
Everyone can learn from him even if we can’t invest like him. In fact these wealth creation principles are completely inline with his philosophies. We also question whether day trading any asset is truly practical for your average investor. We know many people who have been on currency, options, futures and share day trading courses. No one was trading 12 months after they had been on the respective courses, suggesting it wasn’t working.
Anyway, enough of that, we’re not here do an assassination job on get rich quick schemes, that’s another post. What we do want to do is to look at fundamental principles for creating wealth.
So, let’s start to look at the 8 essential wealth creation principles for everyone:
Put Something Away
So, here is the first of our wealth creation principles and this may sound obvious, you need to put money away. You need to invest on a regular basis, whatever suites you best, just keep doing it. You need to spend less than you make, you can’t build wealth if you are servicing debt. Some people will disagree with this especially when it comes to property. We just want to say let’s see how much wealth your building when you have negative equity.
You’d be surprised at the number of people who want to build wealth yet never put anything away. This leads us nicely on to our next of our wealth creation principles.
The Sooner You Start The Better, Though It’s Never Too Late
I’ve met many 55 year olds who hope to retire at 65. They have no pension and very little savings, not a particularly great situation. They’ve paid off their mortgage so they’ll have somewhere to live which is a bit more positive. Now it’s time for them to start to put some serious money away. This is what we make today and we’re going to need this when we retire. What do we need to do?
They find out that with the timeframe that they have and the income that they want in retirement, they have to save a lot. When we say a lot, we mean 70,80 or 90% of what they earn, quite often even more than they earn. The general reaction to this is panic do nothing and then act like an ostrich. The outcome is that they own a house (which they’ll probably have to sell) and have no money to live on. Doing nothing doesn’t make the situation any better it just makes it worse. Revise your income goals or work longer, doing something will make the situation better.
The sooner you start to save the more wealth you will accumulate. Time can be your friend or it can be a cruel enemy when it comes to wealth creation. Even putting a small amount away when you first start earning money will make a big difference down the line.
Invest According To Your Time Frame
What do we mean by this? Well here’s what we mean you should invest according to when you intend to use the money that you are saving.
If you’re saving for a deposit on a house that you plan to buy in the next 24 months, you shouldn’t use capital assets. This means no shares, share based funds, hedge funds, REITS, property funds, bonds, bond funds and all forms of cryptocurrency. What you should be investing in are cash based assets. Find the best deposit account that meets your timeframe and use that.
I hear you say, surely, I could have a little punt on cryptocurrency or some hot tech stock and get a bigger deposit. If you’re lucky yes, or you could be explaining to your wife why you can’t buy the house because your deposit is only now half of what you saved.
The rule here is if you don’t have the time to wait for an asset to recover before you need to take money from it. Then don’t invest in it.
If you do have time to wait. For example, you have a 10+ year time horizon then you should go for it take some risk. Sticking your money into a bank account isn’t going to do it for you, it won’t build wealth. All it does is just keep your money safe or so you think. In reality when you come to need it will buy you a lot less as inflation will have devalued it.
Accept Markets For What They Are
This is a natural progression in our wealth creation principles and closely linked to the previous one. Only if you have invested according to your timeframe can you begin to deal with this investment truth.
All markets go up and down in the short term and some of these shifts look dramatic at the time. Over the longer term these movements flatten as markets recover and move on. This means that the shorter time you have in the markets the less chance you have of making money. Conversely the more time you have in the market the more chance you have of making money.
What about market timing? If you have the ability to predict the future, what, where and when then the world is your oyster my friend. Give us a call because we want to be along for the ride. The issue isn’t so much the what and the where it is the when. Timing the markets isn’t a skill, it’s luck get it wrong and it could be very expensive. If you are doing it properly you should also be shorting the market, looking to make money when markets fall. This can be very expensive if you’re too early as is often the case.
Just pulling your money out of the market means that it isn’t doing anything. When exactly is the time to go back into the markets? By the time that you are happy to go back in you’ve probably missed a big chunk of the recovery.
So if you accept that markets move in both directions and you have the time to ride out the falls you’ll do well. Panic when the market is going against you and start selling down your portfolio you’ll lose money this we guarantee. Remember growth isn’t uniform, usually it comes in chunks.
Invest Regularly Or When You Really Don’t Feel Like It
One of the best ways to build wealth over the long term is to make some kind of regular investment. The reason for this is you invest across the whole market cycle and most importantly you buy at the lows. Also, as with any kind of regular payment such as a mortgage or loan you adjust your life style around them and you don’t notice them. You’re not committing big lumps of capital to the market at any one time so you should be less anxious. With regular investments, market volatility is your friend.
If you don’t want to make regular investments and prefer ad hoc contributions then the second part is for you. So, you have a warm fuzzy feeling about markets, everything is going well and you desperately want to invest, DON’T! Alternatively, markets are really awful. and the thought of investing repulses you more than the thought of Donald Trump sitting on a toilet eating a cheeseburger. then jump in.
Our natural instinct is to invest when things are going well and to avoid markets when they’re not. What this means is we are self-saboteurs, a modus operandi of buy high and sell low. By the way whatever your reason for not making regular investments, it’s not a good one. Get over yourself and start making them you won’t regret it.
Out of all of the wealth creation principles we see this as the most important and yet it is the most overlooked. If you’re not having your portfolio professionally managed by a fund or discretionary manager then make sure it’s getting rebalanced. Or you may have a financial adviser looking after your portfolio then make sure they’re doing this for you. If you’re managing your own portfolio this is an important part of doing it properly. Once a year is enough anymore than this is overkill any less could prove costly. If you are using a portfolio fund or a discretionary manager they should rebalance as part of their process.
What is rebalancing and why is it so important? When your portfolio is set up there should be an allocation model that it conforms to. This model will define the percentage of the overall portfolio allocated to each asset within it. At the end of each investment year some assets will have made money and others will have lost to varying degrees. This will mean that the portfolio doesn’t conform to the asset allocation splits set out by the model. It also means that the risk profile of the portfolio doesn’t meet your criteria.
When we rebalance, we bring the portfolio and the risk profile back in line with the original model. We do this by selling assets that have performed strongly and buying those that have lost money
“Are you ******* mad, we should be selling those dogs and buying more of the good stuff” I here you say and you’d be wrong. This is exactly why most people had nothing left after the tech boom of the late 90’s. It is why most investors will never keep their gains from this cycle of the cryptocurrency boom we’re currently seeing.
Firstly, unless you’re prepared for serious risk then all the assets in your portfolio shouldn’t grow at the same time. If they do it will normally mean that they all go down at the same time as well. As long you’re good with that then you have our respect and you’ll do just fine. Though you should still rebalance. Most people aren’t which means they have some diversity in their portfolios. Different asset classes doing different things help to reduce the overall risk and volatility of a portfolio.
The likelihood is that the assets that performed well this year may not be as strong next year. The assets that were weak this year will probably be stronger over the coming year. Rebalancing helps us lock in the gains from those winners and make sure that we buy the losers at a reduced price. This also means that the losers don’t have to recover completely before we make money and if they do we make more money. Rebalancing will also mean that your portfolio maintains the risk profile that you’re comfortable with.
Make Sure That You’re Portfolio Is Multi-dimensional
What we mean by this is that you shouldn’t just have assets that only make money when the price goes up. Commodities, art, wine you get the picture (pardon the pun). If these assets fall in value you can only wait for them to recover or sell at a loss.
The stupidest investment that anyone can make is to buy a property and then leave it empty. You have to have more money than sense, it doesn’t matter how wealthy you are. You can do something way better. One of the most attractive parts of property investment is the rental income as it supercharges returns. This holds true for any investment dividends on shares and the coupon on bonds boost your annualised returns.
As we mentioned earlier any market has good and bad periods without exception, even property. When we get an income from our investments even though the value may have fallen it makes the situation more palatable. It also means that the investment is making you money even when it isn’t growing. If you reinvest the income it averages out your position and makes the most of any market falls. In the long run your investment will be more efficient.
It’s OK to have some of this type of investment (never empty property) and it will diversify your portfolio. This in turn will make the portfolio more resilient as you have more assets doing different things. Too much isn’t good as you start to forego too much of that lovely income.
Minimise The Costs For Your Situation
Investing costs money and no one does anything for free. Nor should you expect them even those nice people at Vanguard have charges. If you want your portfolio managing for you then you will pay more. If you are happy to manage it for yourself then you are going to pay less. As long as you get things right. Whatever your circumstances it’s important that you try and keep investment costs to a minimum. Get good value, if costs are too high then your portfolio’s sluggish or it won’t grow at all.
Any investment strategy has layers of costs and some more than others. If you’re going direct to the fund manager then your cost structure will be simpler which is great. The downside to this is that the manager may not have a full range and it certainly won’t be strong in every sector. As a result, you may be losing more in growth than you’re saving in fees.
We’re not going to get embroiled in investment strategy today it isn’t what this is about. What we will say is whatever your preferences an investment platform is probably your best option. Not all platforms are equal so it is important to make sure that you get the right one for you. Firstly you should be able to buy the assets that you want through it cost effectively. If you are a passive investor then it wouldn’t do to use a platform that has strict minimum trading conditions. If you don’t want to manage your own portfolio then there is no point opening an account that doesn’t have managed funds or accepts third party managers.
Expats be warned
A note of caution to expats past, present and future. The complete opposite of keeping costs to a minimum is using an offshore life insurance company investment. We’ve used them for clients a long time ago because there wasn’t any alternatives and we did so responsibly. By this we mean that we tried to use either flexible contribution options or short investment terms. Today there are better options, for example our Hallmark Account is one though there are others available to expats. If you want to know why these offshore life insurance investments are so bad for you please see our post “Financial Health Warning”.
Become A Gardener Or Hire One That You Like
Investing is a lot like gardening. You need to have a plan if you don’t then you could get into an awful mess. First you need to do the research, what goes where and works well in which conditions. Then you have to see what you do and don’t like. What are you going to be using it for? This also has a significant impact on what you’ll do. Making sure that you have the right plants in the first place will save you time and money later.
Once you’ve got your plan together then you need to start planting. It may not look great at first because things need time to settle, bed in before they start to grow. At this point you need to be patient, leave things alone and give them the time they need. Keep digging things up because they’re not growing fast enough and they never will.
Sometimes the weather will take its toll, there’s no need to dig everything up and start again. Tidy up add some more plants back to the areas that got damaged the most and carry on. Otherwise just keep things tidy and do the maintenance that’s needed when its needed.
Gardening may not be your thing and yet you’ve got a garden. You may or may not know what you want from it. If you don’t want to do all this yourself then find someone to do it for you and pay them. Make sure that you can work with them and get going.
Apply these wealth creation principles to your investment strategy and you’ll do well and financial freedom will be close at hand.