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Sunday, January 9, 2011

Wealth cannot be accumulated through addition but is created through multiplication

Wealth Creation

The amount of wealth a person owns becomes the subject of envy or discussion amongst his peer group, friends and relatives.  

There are only a lucky few who have become millionaires overnight or are actually born with a silver spoon in their mouth. Rest of the affluent lot that we see around us have actually made it big for themselves by working hard and smart. They had their plans clear and saving / investing gained priority for them over consumption and this is how over the years, they were able to amass wealth and become, what we in common parlance call, ‘Rich and Wealthy’.

It is a truth universally acknowledged that wealth cannot be accumulated through addition but is created through multiplication. This means that you can create wealth by judiciously investing your savings across different asset classes and not by adding cash to your Savings Bank A/c.

As you embark on this goal to create wealth, first decide how much amount you want to accumulate and in how many years. Based on these details, calculate the amount that you should be saving / investing periodically and carry out the feasibility analysis of the result so attained. Thereafter, invest the amount in a suitable asset allocation towards the achievement of your goal of wealth creation.

As you decide on the avenues to invest in, make sure that you consider the following factors towards making an informed decision:

·         Time Horizon: It means the tenure for which you will invest your savings. The time horizon of your investments should match the time horizon of your goal.

·         Asset Allocation: Choosing the right mix of asset classes, while keeping in mind your risk appetite is very important.

·         Power of Compounding: As you invest systematically and regularly towards the achievement of your goals, you tend to benefit from the Power of Compounding, thereby improving the overall return on your investment. This is how it works:

By investing Rs.5000 per month for 5 years at an expected return of 15%, you can accumulate a corpus of Rs.4.05 lac and this same amount invested per month at same return expectation will grow to Rs.12.20 lac over a term of 10 years. Also, the rate of return that you earn has a great bearing on the overall portfolio growth.

Simply stated, if your goal is to create a significant amount of wealth, you should start investing for long period of time, in a variety of investment avenues, suiting your risk profile
Prudent Asset Allocation is very significant to reach the desired goal. It involves dividing an investment portfolio across different asset categories, such as stocks, bonds, cash and real estate, gold, etc.

The process of determining the correct asset mix is completely dependent on how much risk you are able to take as well as the time horizon that you have in view.

By including asset classes that are have low correlation or negative correlation; the investor can stabilize his overall portfolio return, thereby reducing the overall risk. Historically, the returns of the major asset categories have not moved in the same direction at the same time. So when equities are not faring well, you can find opportunity in debt instruments and if you have proportionately invested in both these asset classes, you are able to shield yourself against extreme movements in your portfolio.

Finally, it is important to assess the performance of the investments at least once a year and if you see one investment option that is consistently under-performing, transfer your money to another one that performs consistently better. But you must also remember that even the best investment options can sometimes undergo a period of underperformance.

So even if you are advised to weed out the under-performers, don’t be too rash in your decisions. At the least, re-evaluate your portfolio every year or two to give a better picture of their long-term performance and wealth creation.

Plan now, before it is too late!

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