Pay yourself first
The need to have a budget is to control expenditure & cash flow to ensure that some of the money you earn can be used to create wealth or save for the things you need. Spending less than you earn and identify regular savings is a starting point in accumulating wealth.
Maintain a cash reserve
Holding a cash reserve or having access to funds at short notice will ensure that you can meet unexpected expenses and emergencies without the need to sell your investments.
Formulate an investment strategy
A formulated investment strategy provides a framework to allocate capital between different investments such as cash, fixed income, property, shares & alternative assets and should be flexible enough to take tactical advantage of market cycles and changing economic conditions. An investment strategy provides a reference point to benchmark the performance of your investments, diversifies your investment across the main asset classes and ensure that your investments are in line with the level of investment risk (i.e. potential for negative returns or loss of capital) you are willing to take to achieve your financial objectives.
Fundamental to developing an effective investment strategy is identifying your financial objectives (such as accumulating funds to buy a home, pay for education, provide income in retirement) and aligning these objectives to the need for income and capital over various investment timeframe(s). For example, short term (less than 12 months), medium term 2-5 years or long term 5+ years.
An investment strategy will determine the asset type and style of investment management that meet the aims of the investment strategy and hence your financial objectives.
Take advantage of compound interest and time invested in the market
By regularly investing into the market and reinvesting income, distributions & capital gains received from investments will take advantage of compounding interest over time will increase the value of your investments. Staying invested in the market over the long term, through economic and market cycles will provide a strong basis to generate long term wealth.
Protect your wealth & most important assets
Your ability to earn an income, protect your assets and your family’s future in the event of loss/damage or personal risk i.e. death, serious illness or injury, will have a major impact on your financial well-being and ability to accumulate wealth. A financial plan will ensure that major assets can be replaced and personal risk minimised through insurance so you can continue to receive income and lump-sum funds are available to pay off debt, medical, education and living costs.
Minimise non-productive debt
Minimise non-productive debt (e.g. credit card debt) so your income is not continually absorbed by servicing debt, repaying non-productive debt means that you increase your net wealth and improve your cash flow position so additional funds can be invested to accumulate wealth.
Use debt productively to increase wealth
Gearing or borrowing to invest to increase wealth can be used as part of your overall investment strategy. Borrowing to invest has the potential to increase capital gains in a rising market, but can also increase your losses in a falling market.
Generally, borrowing to invest in growth assets such as property and shares should be viewed as a long term strategy. I.e. an investment time frame of at least 5 years to allow for sufficient capital growth to occur and the benefits of gearing the investment to be realised.
Fundamentally, gearing an investment only makes sense if;
- The income received from the investment (after taxes and all expenses) is expected to increase in the future and give a reasonable return on the equity invested, or
- The market value of the investment (after taxed and expenses) is expected to increase at a rate that exceeds the negative cash flow (after tax).
Reduce tax and unproductive investment costs
While reducing tax should not be the single basis of investment decisions an effective strategy to legally minimise tax should form part of your financial plan and wealth strategy. Investment costs such as administration, product and transaction costs should reflect the level of value add or extra investment performance gained relative to the costs incurred. An effective financial plan should identify the total cost of investing and ensure the costs are reasonable so investment returns aren’t unnecessarily impacted.
Where to hold investments
Investments may be held personally, via superannuation, company or trust structures. Determining the best structure to hold investments will depend on a number of factors. For example:
- The complexity of your personal circumstances,
- Costs associated with setting up and administering the applicable structure,
- Tax & retirement planning,
- Asset protection issues, the
- Need to hold insurance to protect wealth,
- Access to income and capital,
- Estate planning and beneficiary entitlements.
Periodically review your financial plans and investment strategy
To accumulate wealth over the long-term it is important to periodically review your personal and investment objectives. This will allow you to take advantage of opportunities as they arise and adapt the plan to cater for changes in your circumstances or as a result of external factors such as change to government legislation or economic and market conditions.