Everybody wants to know the secret to making lots of money fast. Be it an inheritance from a Nigerian prince or an old acquaintance recruiting you to join his latest multi-level marketing (MLM) business, the world is full of get-rich-quick schemes. But let’s face it, if there were truly a way of getting rich overnight, we’d all be doing it.
The reality is that while you can definitely build wealth and grow rich over time, getting rich quickly is a tall order – at least not without plenty of luck or taking a significant amount of risk.
Instead, the most realistic path to attaining wealth over the long term is through investing.
While there is no magic formula behind investing success, smart investors all adhere to the following set of time-tested principles.
#1. Saving and investing early
Growing wealth starts with saving money. The more money you save, the more you have to invest. And the earlier you invest, the more you accelerate the rate of compound interest, and by extension, the growth of your money.
Consider the example of two friends, Jack and Jill below.
Jack starts investing at age 30 and invests $10,000 every year until he turns 40. From age 40 to 60, he doesn’t invest at all. Jill only starts investing at age 40 and invests $10,000 every year until she turns 60. Surely her deck must be stacked against Jack.
Not so. Assuming a conservative 7% average annual rate of return, Jack’s total portfolio was actually worth $719,915 while Jill only had $438,652 by the time they turned 60.
Jack’s investing headstart more than offset Jill’s greater total contribution, boosted by his compound interest earned over 30 years. Don’t wait to invest. Start now.
#2. Manage risk first over returns
Many investors focus on investment returns and tend to forget that managing risk is at least as important – if not more so.
Risk can be defined as the likelihood of a significant loss. To understand the importance of managing risk in creating and preserving wealth, imagine this. If you lose 50% of your portfolio value, your remaining investment has to make a 100% gain just to get back to even.
Risk management thus seeks to limit your downside risk and minimise loss. While all investments carry a certain amount of risk, understanding the risk / reward trade-off can help protect your investment portfolio. Remember, while lower risk translates to lower returns, taking on more risk does not always equate to higher returns.
#3. Don’t put all your eggs in one basket
Investing in a diversified portfolio made up of different asset classes can further help you spread your investment risk. In a diversified portfolio, the assets don’t correlate with each other. This means that they tend to react differently to the same economic event (like a recession) and their performance differs from each other. Your overall portfolio risk ends up being reduced because when some of your assets perform poorly, others can bring profit.
Beyond diversifying across asset classes, it is also important to diversify within each asset class. An example would be Syfe’s sample 15% Downside Risk portfolio, as shown above. The portfolio is invested in a mix of stocks, bonds and commodities – and its stock allocation is further diversified with holdings in large-cap stocks, emerging market stocks, technology stocks, and more. This can help you avoid the peaks and troughs of individual asset classes or sectors, and deliver more stable returns over the long run.
#4. Minimise investment costs
If fund costs are incurred regardless of fund performance, then it is a mathematical certainty that the lower your costs, the more you get to keep of any returns the fund makes.
This is a key reason why low-cost passive investments like exchange-traded funds (ETFs) have become hugely popular in recent times. Compared to ETFs, investors pay more in fees when they invest in actively-managed investments such as unit trusts.
High fees can eat away at your returns. A hypothetical investment of $100,000 invested at an annual return of 5%, would be worth $324,000 after 30 years if the annual investment cost totaled 1%. If the investment cost was 2%, the final investment value would only be $242,000 – $82,000 less.
#5. Stay invested
Successful investing is ultimately a matter of staying the course, even during periods of extreme volatility. History proves that panic-selling during a downturn almost always ends poorly for investors.
Many investors sell their stocks in panic during a downturn and re-enter the market only after a recovery has happened. Missing even a few trading days could mean missing some of the market’s greatest gains.
An investor who had invested $100,000 on 1 January 2009 – in the midst of the global financial crisis – but missed just a month of trading (or the top 30 trading days), would have had US$74,453 less by the end of the year compared to if he had stayed invested for the whole year.
The stock market has historically favoured investors who take a long-term approach. With average returns trending positive over longer horizons, it pays to commit to a long-term investing strategy and stay invested, even if stock market returns can vary greatly from year to year.
By adhering to these five investing principles, you too, can make your money work for you more effectively and reach your financial goals sooner.
For a more comprehensive guide on how you can save more and invest better, download the free “Take Charge Of Your Wealth” e-book, available here.