THE FIRST STEP towards building wealth is to avoid spending all that you earn.
In other words, you start building wealth by saving. Having examined spending and saving extensively, let’s consider the next critical step.
That next step is to invest the amount saved. Today we look in detail at investing – what is investing, and why invest at all.
You invest when you place your money or money’s worth into an endeavor with the expectation of earning additional income or profit. When you invest, you put your money to work for you in order to get more money, often called passive income.
On balance, everyone would love to have more money in order to enjoy more leisure activities, to afford to buy more of whatever they fancy for enjoyment, or to increase their sense of freedom and security. In order to earn more, there are a number of options: for example working longer hours; moonlighting at a different job; getting a raise in pay; or getting a higher-paying job.
However, working longer or harder usually absorbs the time that would normally be spent for leisure. You may hardly have the time to enjoy the extra earnings that you make while extending your work and earnings in this way.
On the other hand, when you set your earnings that you have saved to work for you by investing, you can be earning additional income while you are working, sleeping, socializing, enjoying a cruise, or whatever you care to do with your time. So the main reason you invest is to earn additional income or profits from your savings. This is income or profit that you would not have earned from working. The only connection to work is that you would have saved some of the income that you earned at work in order to make that investment.
A very important point to make is that gambling is not investing. When you gamble, you are entirely at the mercy to Lady Luck to win money or money’s worth, otherwise you lose your entire bet. Gambling involves an outright hope that luck will come your way.
Yes, certain investments carry quite high risks. Yet there is a reasonable expectation of making additional money when you invest. That is the key difference between one investor and the next – their disposition to risks.
One investor may be disposed to tolerating high risk, typically with the expectation of making a higher return, whereas, another investor may be quite conservative with respect to their investment risk. Both investors will still hold a reasonable expectation of a return on their investment. Their investment commitment is usually based on an analysis of the available information about the investment and they look to more than Lady Luck for their return.
So why invest at all? If you just save your money and keep it under your mattress, inflation and the rising cost of living will reduce the absolute value of those funds. It is important to point out that the saving fund will still be more valuable in the long term than if it had been spent on depreciable assets like a vehicle or, say, furniture. Investing is aimed at assisting, at minimum, in maintaining the value of the funds. Once the rate of return earned on the investment is higher than the inflation rate, the fund will grow in value over time; then your money will be working for you by creating additional value.
• Louise Fairsave is a personal financial management advisor, providing practical advice on money and estate matters. Her advice is general in nature; readers should seek advice about their specific circumstances.
