When it comes to wealth creation, there is no magical formula that applies to all. But commitment towards savings and investments, and the security provided by insurance, goes a long way in creating wealth. To multiply your hard-earned money, you need to opt for financial tools that give inflation-beating returns in the long run.
Once investment instruments are identified based on your income, risk-taking abilities, age and time in hand, you have to look for ways that can help in maximising returns. Wealth creation wonâ€™t happen overnight. It will have to be little steps taken thousands of times. Here are some tips to get you going.
Time is money. So, you should not waste it and start working on wealth creation as soon as you start earning. Starting early gives your money time to grow and you can later benefit from compounded growth. Compounding helps your money grow manifold with time. For example, if a 22-year-old individual starts investing Rs. 50,000 annually in 2020 in the Public Provident Fund, he would be able to build a corpus of Rs. 13.56 lakh when he turns 37-years-old in 2035 (assuming the current interest rate of 7.1% p.a. throughout the tenure of 15 years) that could help him pay the down payment for his house or build the foundation of his retirement fund. Of course, the returns would be higher if the interest rate or invested amount increases during the tenure.
Another way to maximise returns is regularly reinvesting the return earned on your investment to further benefit from its compounding power. Even a small but regular investment can grow much bigger than a large investment done later in life if you start early.
Step-Up Your Mutual Fund Investments
Mutual funds are a great investment option if you are looking for flexibility and higher returns. To improve your investment performance, you can consider increasing your exposure in mutual funds with any surplus amount or increase in income according to your financial goals and risk tolerance. Letâ€™s say your income increases by 10% in a year, so you should increase your SIP by 10%. Increasing your investments annually will help you accelerate towards your financial goals, which will make it easier for you to beat inflation. For example, a SIP of Rs. 10,000 in an equity fund for 15 years (assuming 12% p.a. returns throughout and 10% step-up in investments every year) would build a total corpus of Rs. 86.39 lakh after 15 years with total investments amounting to Rs. 38.13 lakh. Without the 10% annual step-up, the same SIP of Rs. 10,000 for 15 years would build a corpus of just Rs.50.45 lakh (assuming the same 12% p.a. returns throughout the tenure), i.e. Rs. 35.94 lakh lesser than the corpus of Rs.86.39 lakh after a total investment of Rs. 18 lakh.
Ladder FDs To Maximise Returns
Risk-averse investors, like people close to their retirement, prefer investing in fixed deposits for assured returns. However, the FD rates are lower than the prevailing inflation rate at times, leading to erosion in capital invested. To avoid this, you can consider deploying an investment strategy called the FD laddering technique. Under this technique, instead of investing your entire corpus in a single FD, you can break it into multiple FDs with different tenures, and keep reinvesting each of them if feasible to create an investment loop. For example, if you want to invest Rs. 5 lakh in fixed deposits, instead of investing it all in a single FD, you can break your corpus into five deposits each amounting to Rs. 1 lakh with tenures of 1 year, 2 years, 3 years, 4 years and 5 years, and continue reinvesting them on maturity. This strategy would help you get better returns whenever there are higher interest rate offers in the future and might generate higher returns in total. More importantly, youâ€™ll be better positioned to meet any short-term or unexpected fund requirements without having to pre-close your FD after losing interest income.
Invest According To Your Risk Tolerance, Not Risk Appetite
Risk appetite is a generalised notion of an investorâ€™s willingness to take risk but risk tolerance is the investorâ€™s actual ability to take that risk. Itâ€™s crucial to invest according to your risk tolerance which might be different from your stated risk appetite. For example, your age and expertise could define your risk appetite but things like your income, expenses, savings, debt-repayment record, liabilities, existing investments, insurance protection, etc. would define your risk tolerance. Now, if youâ€™re young, you will have a high risk appetite. But if youâ€™re young but youâ€™re also struggling to repay your loans in time due to stagnating income and excessive expenses and do not have adequate insurance cover or emergency fund in place, your risk tolerance would be lower even if your risk appetite is higher. On the other hand, if youâ€™re nearing retirement age but have already repaid your loans and have adequate savings and insurance cover to safeguard your familyâ€™s future requirements, your risk tolerance could be higher than your stated risk appetite. If you want to maximise wealth creation, you should assess your risk tolerance level and be ready to take the appropriate level of risk when there are requirements and opportunities.
Be Prudent In Borrowing
Smart borrowing calls for going for a loan that you can comfortably repay in time. It is also about spending on things that have a future value or things that can increase your net worth. You can ensure prudent borrowing by following steps like researching to get the best loan offers, avoiding unnecessary borrowing or over-borrowing, keeping credit card expenses under control, putting in place standing instructions for auto-debit of monthly dues to avoid paying additional interest for late or missed payments, making adequate pre-payments for home loans, etc. These habits could ensure timely repayments and closure of loans and contribute towards maximisation of wealth-creation goals in the long-term by freeing up more money for critical investments and insurance purchases. Also, smartly managing your debts would do a world of good in improving your credit score that would help you land the best loan offers in the future.
Other Points To Keep In Mind
While creating wealth, focus on spending less and saving more. You must have a budget in place to segregate your income and high-priority expenses like loan EMIs, rent, groceries, utilities, childrenâ€™s school fees, etc. This will give you a fair idea about how much money you can save and invest. You must also maintain an adequate level of emergency fund to keep you going in case of unexpected events like job loss or accidents. You must also mitigate health risks by having in place adequate life and health insurance cover for yourself and your dependents. While investing, you should also diversify optimally across different instruments and asset classes to keep the overall risk under control.
Wealth creation is a long-term and consistent process. Always practice strict financial discipline and investment smartly in strict accordance with your financial goals, risk tolerance and liquidity requirements.
The writer is CEO, BankBazaar.com, Indiaâ€™s leading online marketplace for loans and credit cards.