Wealth creation involves building assets by following a careful and disciplined asset-based investment pattern. It usually takes a long period of time to achieve and generate an income stream that ensures a continuation of good quality lifestyle for an individual during the years beyond retirement.
The following principles govern the process of wealth creation:
1. Pay Yourself First
We normally tend to save whatever is left out of our income after we have met our expenses. Thus for us the mathematical formula generally accepted is:
Savings = Income – expenses
However, for creation of wealth, we need to spend what is left after we have saved. The mathematical formula that guides wealth creation is:
Expenses = Income – savings
Savings is a matter of choice. In our society, we come across two kinds of people, one who can save and one who cannot. We therefore, find a person with an income of Rs 5,000 per month able to save Rs 500 for his future. At the same time there may be a person with a monthly income of Rs 25,000, but not able to save even a rupee and swipes his credit card to borrow money for his monthly expenses!
Savings means building a fund, which you keep aside for your future and is akin to paying for yourself. Those who create wealth pay themselves first before paying for anyone else.
2. Save Now
We have heard of the power of compound interest. This power can create a difference in long-term planning.
If money were to double in 5 years, Rs 1,000 invested at the beginning of the period would grow as follows:
In the above table, the rate of growth is same and no new money is invested during the term. In the first five years, the money grew by only Rs. 1,000; however, between the years 25 and 30, money grew by Rs. 32,000 in absolute terms. Had the money been kept for another 5 years the amount of growth would have been a whopping Rs. 64,000! The above example clearfy illustrates that longer the period of investment, better is the manifestation of the power of compounding. Hence, for wealth creation we should start investing as early as possible. Postponement only means losing the benefits of the power of compounding.
3. Get Rid of Loans
Taking loans for the purpose of spending is a bad habit and hampers the process of wealth creation. Please refer the table below to understand the difference between savings and loans:
|Savings are voluntary in nature||Loans lead to forced payments from future income|
|Savings arises due to a decision to spend today’s income for future needs||Loans arise out of spending future income to meet today’s needs|
|When one saves, he/she can generate a return on the savings, which adds to the amount available to spend||When one raises a loan, he/she has to pay interest on the loan. This reduces the amount available for spending|
|Savings is the cheapest option to meet a known future expenditure.||Loan is the costliest option to meet expenditure. In the absence of adequate savings one has no option, but to raise a loan.|
To create wealth, one needs to do away with loans, which have been raised to meet current expenditures. He/she should not only look at meeting expenses from its current income, but also save for future.
4. Pick out the right mortgage
Housing loan is one of the biggest expenses that middle class families undertake in their lifetime. Therefore, it is not only important that the expenses are incurred in those properties, which appreciate in value or have the capacity to earn good rent income, but also to ensure that the mortgage is right. A wrong mortgage can lead to depletion of wealth! By right mortgage we mean that there are tax concessions on the amount repaid, the installments are convenient and can be paid over the duration of the contract etc. It is also important that proper advice is taken with respect to the property purchased and the terms and conditions of the mortgage.
5. Build an emergency fund
It is advisable to keep at least three times of our monthly income in liquid assets as emergency fund to meet financial emergencies. In the event of an emergency, if there is no emergency fund, you will have to borrow money at high rates of interest which does not help in the process of creating wealth. In the process of wealth creation it is therefore important to build an emergency fund.
6. Protect your assets
Assets act as security covers in the absence of adequate insurance. For example, in the event of death of the breadwinner, in the absence of life insurance plans, the assets will be sold to meet the liabilities of the deceased. To prevent such a situation, it is better to insure at least to the extent of all liabilities. If the income stream of the family is cut off due to death, sickness or disability of the bread winner then the family will have no choice but to sell off the assets. However, in case the bread winner is insured then the assets are protected and the family can generate income from the insurance money.
Mr. Tripathy joined HDFC Life in 2004 and has been responsible for Marketing Strategy, Brand Planning, Advertising, Communication & Media, Customer Insights, New Product Development, Product Life Cycle Management, Online and Digital Strategy, E-Commerce, Customer Analytics, & Corporate communication. He started his career with GCMMF Ltd. in 1992. Since then he has worked with various reputed organizations like Frito-Lay (PepsiCo), Mattel and Reliance Infocomm before moving on to his current role at HDFC Life.View Complete Profile
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