Creating wealth through investing doesn’t have to be daunting. By understanding and sticking to some important investment fundamentals, creating long-term wealth can become a reality.
From understanding the difference between saving and investing to the importance of diversification, we focus on the golden rules for investing. We also provide case studies which help explain how these concepts work in everyday situations.
Remember, these fundamentals are only a guide and don’t take into account your own circumstances. To make the most of your investments you should discuss further with your advisers how these strategies could work for you. We can then develop an investment plan that suits your goals and financial situation.
1. Seek advice
Good advice adds up
The importance of obtaining good financial advice can’t be overlooked. From helping you formulate realistic goals and objectives to effective tax planning, it is a valuable part of creating wealth advice.
Your adviser can help you plan ahead
Developing a plan is the first step to achieving your financial goals. Here are some easy steps to help you begin:
Don’t just save
Saving and investing aren’t the same thing. With saving, you hold your money to use in the future, instead of spending it now. Investing involves putting the money you have saved to work. The ultimate aim of investing is to accumulate wealth, however you may also choose to generate income from investing. It’s essential to invest your savings if you want to make the most of them.
2. Be an early bird
The more time you have to invest, the more likely you are to reach your financial goals. It may sound obvious, but let’s take a look at an example.
Meet Chris and Linda
Lively Linda is a keen investor. From 25 years of age, she invests $2,000 p.a. in a managed fund earning an average of 8% p.a.
Chris doesn’t start investing until he turns 40 years of age at which point he invests $5,000 p.a. for the next 20 years, also earning 8% p.a. Both Linda and Chris retire at 60 years of age. Let’s take a look at how their wealth grows over time.
As the chart shows, despite putting aside less total savings, Linda has created more wealth than Chris. This is simply because Linda chose to invest earlier.
Assumptions: Calculations do not take taxation into consideration and assume both investors earned 8% p.a. The results may vary if different dollar amounts are invested and if the return earned is higher or lower than 8% p.a. at different times.
3. The time is always right
Everyone can find a reason not to invest. People watch the newspaper headlines go up and down with good and bad news and decide whether it’s a good time to invest. If you look at the index over the last 40 years, you’ll see it didn’t stop growing despite blips in the market.
The All Ordinaries index is a measure of the average price of shares on the Australian Stock Exchange.
Investing across different asset classes is a good way to reduce risk. By spreading your funds across different asset classes, you remove the risk of ‘putting all your eggs in one basket’ i.e. the risk you will choose the wrong asset class at the wrong time. Different asset classes perform better at various times and it’s impossible to predict which one will be the star performer in a given year. The table below shows asset class performance over a 20 year period.
5. The benefits of dollar-cost averaging
Trying to predict the best time to enter the market is near impossible. Dollar-cost averaging is one useful technique to help iron out the ‘ups and downs’ of the share market. Instead of buying $6,000 in shares at one point in time, you may choose to spread your investment across regular time periods. e.g. $500 every month for a year. By spreading your investment over time, you take away the problem of attempting to determine the ‘top’ or ‘bottom’ of the market. Let’s take a look at an example.
Meet Eric and Danni
Eric decides to wait until the market is running upwards strongly before he invests his $100,000 while Danni decides to reduce her risk and invests $10,000 every month, regardless of what the market is doing. Let’s take a look at an example.
At the end of 10 months, we see that Danni has made a profit, while Eric made a loss. This is the beauty of dollar cost averaging.
Volatility reduces over time
Each investment should have a suggested minimum time horizon. This is the minimum period of time you should consider holding your investment. Holding an investment for the suggested time does not guarantee a positive return, but it does increase the likelihood of it happening. However, if you are tempted to time the market, i.e. selling assets to avoid further falls, there is the risk of missing out on market rises, which often come after the falls.
Timing the market is very difficult and even the most sophisticated investor can incorrectly judge short-term movements. Taking a longer-term view and being prepared to ride out the lows may, in the long run can help to maximise the value of your investment.
As we can see in the graph below most asset classes experience fluctuations in short-term returns, but have provided positive returns over time.
Timeframe: 31/12/1982 - 30/03/2008
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