Step 1: Looking at yourself
Making the move from saver to investor is your first step on the road to building wealth. It's only by putting your money to work that you can really get ahead.
How do people become wealthy? Some people inherit money, some people build their own business, some have a lucky break – but for most of us building wealth is about astute, well-researched investment backed by sound advice. Even starting with limited resources, it's possible to realise your financial goals.
But, first, you need to know a few things about yourself. What are you investing for? What do you want to achieve, and when? How willing – and able – are you to accept risk?
What are your goals?
Are you looking to invest for the short to medium term, maybe to buy a car or fund your children's education? Or are you hoping to build wealth for your retirement? Perhaps you want to generate a regular income now.
What are your specific targets? It might be a certain level of income in retirement or enough money to meet private school fees. Once you know this, you can work backwards to establish what you need to do to achieve your goals.
This will involve balancing risk and return. An important rule of thumb is: the higher the risk, the higher the potential return (and vice versa).
If your financial target is high but the amount of time you have is short, you'll have to consider whether you should take on more risk in the hope of a higher return – or perhaps revisit your financial goals.
The longer your investment horizon, the more risks you can afford to take to achieve your goals. In 10 years' time, a slump on today's sharemarket won't mean much to your ultimate return – but if you're looking to cash in your investments in the short term you'll have to bear in mind that you may not have enough time to recover from any losses in the meantime.
Tools: Work out what you can earn from regular savings
Appetite for risk
Once you've established your goals, you need to consider what type of investor you are.
Everyone's different – age, investing experience, financial resources and personality type all come into play when determining your risk profile.
Are you a cautious investor with little appetite for risk, or someone with the time and money – and inclination – to take on more risk in the hope of achieving higher returns? Have you owned shares before or are you a first-time investor? Are you comfortable borrowing money? How would you react if you experienced a low or negative return in any one year?
Assessing what sort of investor you are is important. While you want to maximise your returns, you don't want to take on a degree of risk that's outside your safety zone.
By the same token, in thinking these issues through you may come to realise that you are an overly cautious investor and that you can safely step up a notch.
The basic asset classes can be placed in an investment risk 'pyramid': with cash-type or secure investments such as cash management trusts, savings accounts and government bonds forming a solid and safe foundation; medium-risk assets such as property, shares and corporate bonds taking a more modest share in the middle; and more speculative investments such as collectibles, options, futures, and 'alternative' investments like hedge funds the smallest part at the top,
Ask yourself the following questions:
- Why do I want to invest?
- What are my specific targets?
- How much can I afford to invest?
- How much time do I have to achieve my goals?
- How would I react to a low or negative return?