How to build your wealth from scratch

The pandemic has made people more conscious about their financial planning. But, how and where do you begin your journey towards building your wealth.

Here’s a comprehensive guide that investors can follow to build wealth from scratch.

Savings is the key

The first and foremost thing is to start saving as much as possible. Other factors such as inflation, interest rates, and stock prices are not in anyone’s control. So the focus should be on things that can be controlled and not on factors which can’t be!

Also, as a golden rule, one should not save the amount left after spending but should spend the amount left after saving.

In a nutshell, wealth accumulation is a function of your savings. So save prudently.

Turn your savings into investments

Once you’ve set your saving goals, the next step is to put them to work. The value of savings kept idle in the locker, or a bank account will deteriorate as inflation will eat into your purchasing power.

So it becomes necessary not only to save but also to grow your savings.

And growth in savings should at least be more or equal to the growth in inflation levels so that you are not worse off than before in real purchasing power terms. There are various fixed-income and equity asset classes available to grow your savings.

Set Your Risk and Return Expectations

Before actually investing, it is necessary to set your risk and return expectations right. Risk tolerance is a function of your ability and willingness to take risks, where your ability to take risks depends on your financial background. In contrast, your willingness to take risks is more a function of your psychology.

Regarding returns in the Indian context, expecting a 35-45% return per annum from mutual funds is unrealistic, provided that the country’s GDP growth is between 8 and 10%.

So it becomes necessary to set your expectations right to avoid negative surprises at later stages of the investment journey.

Invest in asset classes suitable for you

In this step comes the execution part. It involves selecting the asset classes suitable for you and the right asset allocation mix. The right asset allocation is of immense importance as more than 90% of the investment returns are driven by asset allocation decisions. In contrast, less than 10% of returns come from individual security selection.

There are various asset classes available for investments, such as equities, bonds, alternative investments, real estate (REITs), and commodities which can be considered.

Keep a long-term horizon

After the investments have been made, sitting quietly and not tinkering with the portfolio during stressful market situations becomes of utmost importance, and even the most qualified individuals cannot do so!

Investing for a long-term horizon puts the compounding effect to work. And compounding can work wonders even on small investment amounts, provided the investment horizon is long. For context, legendary investor Warren Buffet’s half of the net-worth was built after his 50th birthday. That’s the kind of horizon one needs to have!

Increase your investments periodically

It is essential to increase your investment amounts periodically to reach your goals faster than before. Increments in investment amounts can be made when you can save more, your financial condition improves, or when the stock markets are temporarily depressed.

Monitor regularly

Regular monitoring ensures that the asset allocation is in place, which might deviate from the standard mix due to changes in everyday asset prices.