Thumb rules to build wealth

‘Building wealth’ is a topic that’s searched by millions of people. Thumb rules to build wealth tries to summarize all the concepts that were discussed earlier, in a different format.

TWO STEPS

Basically, The entire process of building wealth boils down to just two steps:

  • The first step is to control your expenses according to your income and make a surplus out of it. It demands a lot of financial discipline to achieve this step. Many financial principles that would help you to save money were discussed in our first sessions.
  • The second step would be to find assets that have the potential to grown in value and invest your money in it.That’s it. :)

The first step is completely under your control and no one can help you out. You have to work hard, get a job , make a steady income and save some money for yourself. The earlier you start saving, the better it is.

Once you start earning, it’s natural for anyone to think about availing loans to realise their dreams –for example a big car. The bad news is that, more debts prevent you from saving more at the initial years. All successful investors have accumulated more money in their initial years. Early investing has many advantages as we have already explained in one of our previous posts.

Hence, the second step is to gain some basic financial knowledge. You are supposed to know some basic rules and concepts like inflation, compounding, opportunity cost, a bit of taxation and accounting. Learning the basic money magic will dramatically alter your view about finances and investing

The third step – investing, is the one where you will have to consider a lot of things. You’ll have to draw up a plan, list out your financial goals, assess your risk profile, seek the help of experts for valuation of different assets, assess the pros and cons of each type of asset and finally choose the best investment style and vehicle.

In this, drawing a plan and listing out your financial goals with some accuracy is the initial step. Clear cut and realistic financial goals have to be drawn. The most important factor that would help you to bring in realism into your plans would be your level of savings. You can’t draw up big plans if you expect to save only little.

Once you have drawn you plans, you can look for avenues to invest. Here, the best lesson you can get is from Warren Buffet, one of the richest stock investor.  He never invested in businesses which he couldn’t understand. His advice is simple “If you don’t know the business model, what the company does on a day to day basis, or how it generates revenue now, and in the future, then it’s better to stay away from it”. This principle can be applied to all types of investing. You have to make sure that you understand the basics. This advice assumes significance because; investors have a tendency to follow what the crowd is doing. If a particular stock is doing well at the bourses, investors jump in and put money without bothering to analyse what business the company is into. In short, you have to be through with the basics.

Diversification is the next area to be addressed. Diversification of money into different asset classes is required since you cannot predict the movement of asset prices and you cannot say which asset would perform best in a year. So, must have some money in all possible asset types. That’s what diversification is all about.

When you have a mix of assets in your kitty, what you have is a portfolio. Your portfolio will have to be periodically checked, reviewed and rebalanced since the value of assets with you will keep changing from time to time. For example- you have a portfolio in which 60% of the funds are in large caps and balance in mid caps. That year, if the equities go up by 30% and the mid caps fall by 2%, it will imbalance your portfolio and to make it back to that 60:40 levels, you will have to sell large caps that went up and buy mid caps that came down.

All the principles put together, you should be able to make a good return from your money. The thumb rules are:

Rule 1. Make money

Rule 2. Learn the basics of investments

Rule 3. Identify the assets to invest.

Rule 4. Diversify

Rule 5. Review your portfolio.

You may like these posts:

  1. What are the stages in investment process?
  2. Why is investing important?
  3. Investing or gambling?

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