Creating Wealth – 4 Simple Tips
Creating wealth is an important aspect of financial planning which actually helps you meet your financial goals and ambitions. Most middle-class people come across situations where important life goals such as higher education abroad, vacation, buying a house, etc. get postponed or cancelled due to shortage of money or resources.
Why does this happen despite rising salaries? The answer to this lies in the fact that the income earned is not effectively/efficiently converted in to wealth.
Income Vs. Wealth
Lets take a salaried individual Mr.Ravi who earns Rs.50,000 pm in a software firm in Bangalore. His college classmate Mr.Suresh in the same industry in Bangalore earns a similar salary and has similar work experience too. However, if you compare their net worth (total assets – liabilities), Ravi’s networth stands at Rs.2.5 lakh, while Suresh’s networth is Rs.10 lakh.
Based on the net worth Suresh is wealthier than Ravi, though both earn a similar salary income. How? This is because Suresh has a higher networth and has been more efficient or successful at creating wealth than Ravi.
So this brings us to the point that creating wealth requires more efforts than just earning some income. Lets us now see what steps are required to create wealth and how you can benefit from this process.
Tips to Create Wealth
Creating wealth is a meticulous process that requires patience as well as discipline, and flexibility to adapt your financial/life requirements in order to achieve your important life goals (or financial goals).
Have a steady source of income
This is the first step, and is quite obvious that you need to have some income source to meet your living expenses as well as to save for a rainy day or to run your life.
The main source of income may vary according to the individual’s occupation. For salaried people it’s the salary income, while for self-employed or business people its income from profession or business, for investors it could be returns from the investment, etc.
Salary income is the most common among middle class people. Here one has to make sure that the job or occupation provides adequate income and finds ways for improving your qualifications, skill and experience in order to grow in your career and earn more.
This is specific to every individual profession or job, so I leave it to you to decide on ways to generate a steady income.
Tip # 2
Have a budget or plan for generating positive cash flows every month
Sounds simple! True, but many people either ignore this or find it too difficult to implement. If you have no idea about your own spending habits, start with a simple notepad to track monthly expenses. Try doing this for 3 months which will give you an idea of your average spending pattern.
Then see how much you managed to save out of your salary. For example Ravi earned Rs.50,000 and managed to save just Rs.9,000 per month, after deducting all expenses. On the other hand Suresh saved about 18,000 per month.
So this clearly shows how Suresh has been a prudent saver than Ravi. Although in Step 1 both had steady jobs, Ravi lost out in Step 2 due to his lower savings.
Having talked about the importance of saving, I’m not urging you to become a penny pincher or a miser. Instead try to spend smartly on important priorities and save more for a rainy day.
The last phrase ‘positive cash flow’ is very important. Ravi recently found that his loan payments and expenses shot up and leaving him with monthly savings of Rs.5000 or even negative cash flow (which is financed by credit card). So obviously Ravi’s finances are not in good shape since his expenses exceed his income.
This typical problem known as “paycheck to paycheck” living will land you in trouble so mending your spending habits will help you in the long run. Have a plan to clearly define or allocate your income towards essential expenses and some discretionary expenses (if required) and the rest goes towards Savings.
E.g. Suresh allocates Rs.24,000 towards essential expenses and another Rs.8,000 towards discretionary expenses, which leaves with a savings of Rs.18,000 (50000 – 24000 – 8000). But recently Suresh has been cutting down on discretionary expenses to boost his savings.
Savings take care of your immediate future needs and helps you invest surplus funds. Hence, if you have little or no savings you cannot create wealth – its as simple as that. The more the savings, the more you can invest.
Tip # 3
Create Savings for Emergencies/Contingencies
Most people think savings is just a leftover amount after you spend your money. Essentially savings is views as last priority, where you earn, spend on different needs including food, entertainment, shopping, etc. and what is left (if any) is your ‘savings’. This is a flawed approach.
Although Savings is the amount left after spending, you can still control you spending in order to boost ‘Savings’. For instance Suresh has been cutting down on his discretionary expenses (eating out, movies, etc) to boost savings.
Recently Suresh’s savings are in the range of Rs.22,000-24,000, which helped in boosting savings and building up an emergency fund of Rs.2,00,000, which is partially lying in his back account and partially invested in short term fixed deposits.
Why create emergency savings? This is purely a separate saving for any emergencies such as medical treatment, accident, unexpected expenses, losses, festive/other occasions, etc. Even though an emergency may not occur you still need to have it as a back-up.
This is exactly similar to how you have a spare tyre in your car or two-wheeler for emergencies. Another way to look at this is like a ‘reserve’ that helps you in bad days or times of distress. Suresh has kept Rs.2 lakhs for emergencies and invested the remaining Rs.8 lakhs in various asset classes such as equity, bonds, gold, etc.
Tip # 4
Investing your surplus savings
What are surplus savings? Out of your savings, you allocate some amount for ‘Emergency Funds’, and remaining is the Surplus Savings. In Suresh’s case out of Rs.10 lakhs, about Rs.2 lakh is reserved as Emergency Fund, while the remaining Rs.8 lakh has been invested in stocks, bonds, gold, etc.
Why Invest? Investment makes your money productive by generating additional income, which could be in the form of interest, dividend, capital appreciation, etc.
Most people who earn relatively higher incomes feel that investing regularly in fixed deposits is a disciplined way to create wealth. But sadly, it just helps them become good savers, but hardly creates wealth. Investing is an important component of creating wealth, which helps you to build, manage and grow your wealth in the long run.
Some people can get rich without investing, given their higher income, but they are not making productive use of their money and earning paltry returns.
To start investing you need to do the following:-
- Have a plan to invest a minimum sum every month (saving more is even better). E.g. Rs.5,000 every month.
- Based on the above sum have a target to reach a specific Portfolio Value within a time frame. For example if you save Rs.5,000 every year, you could target reaching a value of Rs.1 lakh in 18 months (your savings plus appreciation of investments).
- Identify the various investment assets or products which suit your risk and return expectations. You can discuss this with a financial advisor or learn from investment magazines or publication such as ET Wealth.
- Manage your investments regularly and make required changes/improvements. This will help you book losses (if unavoidable), identify new opportunities, or shift investments from risky assets to safer ones.
- When your wealth grows be cautious as to utilize the sum for important goals or priorities instead of splurging on unnecessary stuff.
- When you have surplus funds without any investment avenues, use it to pay off loans/debts.
In our example Suresh made tremendous effort by investing for last 3 years and built a portfolio of Rs.8 lakhs, which is commendable. He used to divert most of his savings towards investments (started with Rs.12,000 per month and later up to Rs.18,000 per month).
Conclusion – Creating Wealth
Creating wealth is like running a marathon which requires energy as well as endurance. If you save enough and invest regularly you can systematically create significant wealth in the long run. Although you might feel the pinch in the initial stages, you will ultimately emerge a winner.
The steps to creating wealth are simple, but it requires discipline to implement them successfully. Try implementing these steps and see your wealth grow. In the meanwhile if you have any queries feel free to share your questions, comments or feedback.