Category: Money Tips
Created on Monday, 12 December 2011 00:00
Written by Sam Goh
In modern context, the fundamental basis to create wealth is to save prudently. Once you are doing so regularly, you will then move on to the next tier of wealth creation. In this case, you will need to start making important decisions about how to invest your money so as to achieve the eventual goal of wealth accumulation. Many questions have been posed with regard to how to do so effectively and efficiently. Here, I attempt to shed some light.
In my opinion, the primary step to achieve wealth creation and accumulation is to first identify and define your investment goals clearly and in a specific manner. But how do you come up with investment goals that fit your needs?
First, there are a series of important questions that you should ponder, reflect and give some serious thoughts about before the establishment of any investment goals and objectives.
Some of the questions are as follow:
- Why do you need to save and invest your money? – Identify Needs and Wants
- How much money do you need to save? – Target Amount
- How much to invest to achieve your goals? – Amount of Capital Required
- What is your investment time horizon? – Definition of Timeline
- What is the maximum level of risk that you can assume? – Risk Tolerance Level
- What kind of returns are you looking to achieve and earn? – Desired Rate of Return
In the process of establishing the answers with regard to the above questions, it is of vital importance to place a strong emphasis on the need to be realistic. An approach to do so systematically will be to access your current sources of income and determine the appropriate amount for saving and investment purposes. At the same time, due considerations must also be given to ensure that your financial and investment goals are reasonable, measurable and achievable.
The following pertains to some basic important investment concepts that you should be aware of in your quest to grow and accumulate wealth.
1) The Trade off between Investment Returns and Risks
The general rule is that if you want to earn a higher rate of return, you must be prepared to assume a higher level of risks.
In today’s context, there are many different types of investment products in the market. Each product yields a different rate of return with different levels of risks assumed respectively.
For instance, investing in a local currency denominated fixed deposit account with a bank is probably one of the safest forms of investment. It is very important to note and distinguish the fact that foreign currency fixed deposits are inherently different from the traditional local currency fixed deposits due to the underlying currency fluctuations. Hence, foreign currency deposits are typically not regarded as safe form of investment.
In the case of the local currency denominated fixed deposit, the return (i.e. the interest rate) is lower compared to other forms of investment. However, it does not assume as much risks (Exclude Foreign Currency Deposits) as other types of investment products such as equities and derivatives.
As a result, by investing only into fixed deposits, you would not be able to grow your wealth or accelerate the wealth creation process as fast as you would probably like to.
On the other hand, there are other forms of investments that can typically provide you with better returns but at the expense of greater risks. In this case, greater risks pertain to the greater probabilities and possibilities of such investments losing their value.
Let’s take an example to illustrate my above point. Suppose you decide to invest your money into the stock market instead of parking the money into fixed deposits. Here, by investing into equities, you assumed a higher level of risks and face a greater possibility of losing your money than if you were to invest the money into fixed deposits. The primary reason is due to the fluctuation of the share prices of the companies that you had invested into. The fluctuation of the share prices is due to a series of both macro and micro factors such as a decline in company’s earnings, adverse macro economic conditions and more. The risks associated may be further categorized into systematic and unsystematic risks.
2) The Importance of Proper Diversification
One of the main pitfalls of investing is the lack of proper diversification of investment assets. In essence, diversification serves to minimise risks while maximising returns.
However, it is also very important to avoid over-diversifying in too many asset classes. When you invest your money, do not put it your money into one type of investment. If something adverse happens to that investment, you may probably stand to lose all your capital at once.
A better alternative would be to invest in different types of investment asset classes across various geographical regions. In other words, plan for a balanced portfolio of investments.
This is the key to minimise risks. When you engage in diversification, you are likely to reap benefits from your investments while reducing the probability or possibility of financial losses to minimal levels.
At this point of time, another important point to highlight with regard to the action plan of "how and what to invest" must be addressed. In essence, the answer can be determined by your investor risk profile. For this, your financial advisor will have to determine whether, as an investor, you belong to the aggressive, growth, balance, moderate or conservative profile category.
Let’s take a few examples to illustrate my point.
Suppose you are a balanced investor. In this case, you might want to consider investing an equal portion of your money in growth assets such as stocks and in fixed income investments such as fixed deposits and bonds.
If you are an aggressive investor, you might want to consider investing bulk of your money into growth assets such as shares. On the other hand, if you are a conservative investor, you might want to consider diversifying your investment in less volatile investment products such as bonds and fixed deposits.
At the end of the day, do note that you are the only one who has the authority to determine which asset classes to invest and how much to diversify amongst the types of investment products available with due regard to your investment risk profile.
Disclaimer: The views expressed in this article reflect the personal views of the writer. The information provided herein is general in nature and does not have regard to the specific investment objectives, financial situation or the particular needs of any person. Wisdom Capital LLP and its affiliates, directors, associates, connected parties, employees and/or representatives.