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Are you looking for advice on what to prioritize in your financial journey? In this blog article, we’ll explore what should one maximize – annual growth in income, saving rate, or portfolio level return – and how to make the best decision for your financial future.
14-year-old Madhav was very happy when he came back from school today. He announced to his mother, as soon as he entered the house, “I am not going to run any errands for you from today. I have found out another way to get my pocket money.” For the reference here, Madhav’s mother used to give him some money whenever he ran errands for her. This was her way to teach him the basics of earning and spending money.
Out of curiosity, his mother asked him to tell her more. “One of my friends has promised that he will pay us some amount every week, and even some extra amount if we give him all our pocket money now”, he smugly declared. The pride of finding out the easy way to earn pocket money was written all over his face.
His mother raised her eyebrow to express clear dissatisfaction with the idea, but Madhav was ready with another reply. “His elder brother will use the money to start a small business and pay us back when he starts generating profit. All my friends have already given him money for this.”
“I am going to be rich”, he said to himself as he ran off to his room. What a childish mistake, his mother thought to herself. But was he the only one making the mistake in greedy anticipation of easy money? Haven’t all of us fallen prey, once in a while, to attractive investment opportunities without understanding the risks of them? Haven’t all of us thought, at least once, about how to maximize our wealth with the least of efforts?
Do not feel embarrassed. On the contrary, feel proud that you are thinking of doing something about increasing your wealth than just dreaming about it. All you need is to focus on the right things to increase your wealth.
3 things that affect your long-term return and amplify your wealth
Rome was not built in a day. Neither is any portfolio that gives you good returns. It takes consistent efforts and expertise to build a portfolio that suits your investment goals. While you make the efforts, you will need an expert, experienced MFD/RIA, to bring in the skill set to make your portfolio work for you. You and your advisor will have to work together and tackle the challenges to build wealth.
1. Annual Growth in Income
The14-year-old Madhav had understood very well that the first step to invest and build wealth is to have sufficient income. Income that not only provides you enough to manage your expenses but also leaves you with some amount to invest. Providing for your family’s needs, prioritizing your wants or luxuries, and saving for emergencies are important elements of your income and expenditure balance
While there is not much you can do about the basic needs, or emergencies, you can certainly focus on increasing your income. Regardless of your profession, your income is directly proportional to your knowledge, skill set, and your efforts. Invest diligently in increasing your knowledge base and sharpening your skill set to increase your value as a resource. Research and make efforts to develop a competitive edge for yourself in your business or job.
Just like your investment grows at a certain rate, your income should also grow consistently at some rate. A CAGR of 15% is decent growth rate for your income. In simple words, this implies that there must be consistent growth in your income from time to time despite the temporary hiccups. Any negative growth should be set off by another higher growth.
2. Saving Rate
Do not confuse this with your saving bank account rate of interest. That rate is out of your control. But you can always control the rate at which you save. Someone earning more than you may not necessarily have a bigger portfolio. He may be spending all his earnings while you may be putting away some amount every month for savings.
You have a better saving rate than the person spending every bit of his income. And this is what matters in the long run.
Maintaining and increasing the rate at which you save becomes easy if you overcome the need for instant gratification. In other words, the satisfaction of buying something expensive is immensely gratifying but it is also short-lived. Once the excitement of the new purchase dies down, you will realize that it would have been better to invest for a long-term return than to splurge now. For instance, every time a new i-phone is launched, you will be tempted to buy it. But if you overcome that temporary urge, you can stay focused on your larger milestone – a Europe tour with family, your retirement corpus, foreign education for kids, buying your dream home etc.
That does not mean that you suppress all your desires. But prioritize your desires- fulfil some now and keep some of them for later. Even if it sounds philosophical, it is true that attaching your self-esteem to the size of your car is not a very reasonable approach. Keep your eye on the long-term investment milestones and reap the benefits of your discipline.
3. Portfolio Level Return
14-year-old Madhav’s decision to give all his money to his friend had many flaws but the most basic flaw was putting all his money in one investment. Diversifying your risk is the ground rule of investments, no matter how small or big your portfolio is.
An ideal portfolio consists of various asset classes with varying degrees of risk. Equity has historically been considered the asset with the higher rate of return, but it also has the higher risk associated with it. Investing in equity shares is complex and demands a certain level of expertise. You need to read and understand the annual reports of the companies and keep a track of market dynamics and socio-economic factors that affect the movement of stocks. It can be overwhelming, and a small wrong move can wipe out all your investments in one go. It does not mean you should not invest in equity. But before you do that, you need to build certain expertise and financial behavioural traits. And for that you will need to dedicate your time and energy apart from your profession. A better way to do it is to take the help of an experienced advisor and chalk out your wealth creation journey.
For those who want to reap the benefits of equity but want to steer clear of the risk and focus on their profession, mutual funds are perfect. However, this will also need the fundamental financial behaviour traits such as patience and discipline. Mutual funds have become extremely popular in the last couple of decades due to their decent risk to return ratio. Funds operated by reputed AMCs (Asset Management Companies that manage mutual funds) and expert fund managers have helped investors build a considerable corpus in the last few years. The chances of loss cannot be completely ruled out in mutual funds, but they can be reduced significantly.
In addition to the decent risk to return ratio, mutual funds are also investor friendly. You can start investing in mutual funds with as low as Rs 500 every month and keep adding to your portfolio whenever you have some extra funds to spare. Your advisor can help you to not only diversify your portfolio but optimize your portfolio level returns in line with your risk profile.
An ideal portfolio should also contain low-risk assets like gold, debt funds, and government bonds. Although the return is less, the assurance of a low volatility in return compensates for it. Your investment advisor will recommend how much of your portfolio should be made up of these low-risk assets.
What should be your focus?
As much as you want to focus on all three factors mentioned above, it is not possible to manage and maximise them all. Not only will it require a significant amount of time, but it also demands a specific skill set and expertise, just like the ones that we possess here at Finvoyage. Hence, you need to pick the factors that you are good at and have in your control – your income and your rate of saving.
As mentioned earlier, increasing the amount available for investment is a big part of creating a healthy portfolio. You are an expert of your profession. Increase your income through your profession and consistently increase your savings which in turn will increase your investment capital.
Impact of your income, expense and saving rate on your portfolio valuation
Initial Income = 10,00,000
Initial Saving = 2,00,000
Expense Growth = 10%
So, what about portfolio level return now? How one should approach that third thing playing a role in wealth creation? To generate consistent return at portfolio level in line with your risk profile requires very high conviction, behavioural traits like patience, discipline and much more.
A lot of free information is available over the internet, and we are tempted to consider certain attractive options. But all that glitters is not gold. Speak to your advisor to identify the investment options that are best for you while you focus on increasing your income and the rate at which you save.