Financial lessons to help you build wealth

Most investors aspire to create wealth to fulfill their life goals and achieve financial freedom. While wealth creation is the ultimate objective, many investors are still baffled by how to go about it. The simple answer is to spend less and save more, but it is easier said than done. Moreover, savings alone cannot do the job. It is crucial to deploy your savings astutely to let them work for you, that is, to get them to grow passively. There are many other aspects that one must know for steady wealth creation.

Here are five financial lessons that can set you on the right path to building wealth:

Insurance & emergency fund

Insurance doesn’t appeal to most people. When it does, it is generally a savings-linked insurance product, particularly in the case of life insurance. However, term life insurance is a better product to protect your family in case of any unfortunate event. Savings-linked insurance has a higher premium and lower life cover.

Similarly, a health insurance plan for the family is a must to ensure that a health emergency doesn’t hurt your savings. Once you have cracked the insurance piece, strive to build an emergency corpus before starting your investments. You must have liquid money equal to 6-12 months of your monthly income, which you can fall upon in case of financial contingencies.

Take debt wisely

Consumerism is widespread, with people constantly striving to upgrade their lifestyles. Nothing wrong with it, but the challenge comes when they go beyond their means to impress society. Often people take debt to buy a new smartphone, smart TV, branded shoes and dresses, or a fancy car. Debt is good only when it serves a fruitful purpose. For example, most cannot buy a home without a loan, making home loans unavoidable. However, taking debt just because it is available easily may not be a great idea. Don’t splurge via credit cards. Choose your debt wisely.

Goal-based investing

One must invest, and everybody knows it. But for what? It is crucial to have a specific answer to this question. When you define your goals, you get the clarity to select suitable investment avenues to fulfill those goals. For example, you may choose equity mutual funds for your retirement planning, debt mutual funds for your short-term goals, and a combination of equity and debt mutual funds to fulfill medium-term goals. There are many more investment avenues. Choose one as per your risk appetite, life goals, and time horizon to achieve that goal.

Let compounding work for you

Albert Einstein famously referred to compound interest as the eighth wonder of the world. He also said that those who understand it will earn it, and those who don’t will pay for it. Compound interest is interest on interest. For example, if you invest Rs 100 at a 10% interest rate per annum, after a year, you would accumulate Rs 110. Next year, the 10% interest will be levied on Rs 110, making it Rs 121. Next time the entire Rs 121 will earn 10%. This compounding helps you grow your wealth faster if you hold it for the long term. For example, if your lumpsum of Rs 1 lakh earns a 15% interest rate per annum, it shall become Rs 10 lakh in 18 years. However, it’ll take you less than 5 years to accumulate the next Rs 10 lakh, taking your corpus to Rs 20 lakh. The longer you hold your wealth, the faster your wealth grows. That is the power of compounding.

Asset allocation

Don’t put all your eggs in one basket by going overboard on one investment product. Diversify your investment across asset classes such as fixed deposits, equities, and gold. This approach helps you stabilise your returns. If equities don’t do well, gold will support your portfolio. Similarly, debt investment will help you earn safe and decent returns during a rising interest rate regime.

While the crux of financial planning remains the same, wealth creation requires patience and a long-term approach. A calm temperament and realistic expectations can help you to stay on the course and build sustainable wealth.

(The writer is the managing director and chief executive officer at Axis Securities)