2. Investing your savings smartly
Now that you’ve reduced your debit and are saving money every month, you can take the next step to building wealth. There is a perception that investing requires large sums of money, but the reality is many investment accounts have very low minimum monthly contributions making it possible for almost everyone to start investing.
How to invest
To become an investor you’ll be using your money to acquire assets that offer the opportunity for profitable returns. For example:
- Interest and dividends from savings or dividend-paying stocks and bonds
- Cash flow from businesses or real estate
- Appreciation of value from a stock portfolio, real estate or other assets.
Why you should diversify your investment
There are of course risks associated with any type of investment, but to mitigate this risk you can diversify your investment portfolio. If you invest all your savings into the shares of a single business, you could lose all your money should that business fold.
On the other hand, if you invested in a single bond in a handful of top performers and one of them declared bankruptcy, you wouldn’t be left with nothing.
Understanding asset allocation
Another type of diversification is to ensure you invest across multiple asset classes. This is because conditions that cause one asset class to do well often lead to another to have poor or average returns. Splitting your assets across classes will balance your portfolio.
Various factors influence how you decide on what percentage to invest in each asset class, including your risk tolerance and the amount of time you can invest for.
For example: Shares are considered the riskiest and cash-like investments the least risky. Keep in mind, that the greater the risk the greater the reward, so while shares come with the highest risk, they also have the potential for the greatest returns.
Bonds are less volatile in comparison, but they also help a more modest return, with cash-like investment carrying the smallest risk, but the lowest returns.
Case Study: If you wanted reasonable returns and are comfortable taking some risk, you could choose 80% in shares, 15% in bonds and 5% in cash. Alternatively, if you had a shorter time to invest in and wanted a safer option, you would be better off with a more conservative asset allocation with a smaller percentage invested in shares and more in bonds and cash.
Beating inflation with growth assets
It’s vital that your investments are constantly growing, to ensure they aren’t eroded by inflation. If you consider, at current inflation rates, the value of your money today could halve within 12 years. If your investments don’t at least keep up with inflation, you’ll be going backwards.
If you have 15 -20 years to grow your investments, a good option could be local and global equities. Equities is however the long game, short-term disruptions in the market can cause the share price to fluctuate. Ultimately, if you selected wisely, the share price will reflect the business’ growth in profits, which should be above inflation.
Taking the long-term view
“If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes” – Warren Buffett.
If you’ve left starting an investment portfolio till later in life you can still retire with a healthy nest egg, but you will have a vastly different strategy to someone who has 20-40 years to grow their investment.
Investments typically do require a significantly length of time to develop and grow, which is why the faster you start one the faster your money will grow. “While investing for 150 years is not realistic, backing an investment fund for ten, 20 or even 30 years is practical, particularly if you are investing into a pension for retirement,” explains Nick Train, Lindsell Train Global Equity fund manager.
“Investors should find an investment fund with a strong track record, with a manager whose style they like, invest and then leave their money alone for at least five years.” The longer you invest your money for, the more wealth you’ll build.
“There’s no single way to invest your money that’s the “right” way,” explains Ingram. “There are plenty of ways to go about it. The bad news is that it can be difficult to decide which option you’re going to choose.”
There are some easy-to-understand options says Ingram that are low cost and will generate decent growth. A good starting point is to determine your investment goals, such as how long you have to save. The amount of time you have to save will determine which investment options are viable and which aren’t.