Growth, Personal Finance

How to build a lot of wealth starting from zero

The idea that you need to earn a large salary to accumulate wealth, is a popularly held misconception. “The stepping stones to making your first million are actually the foundation blocks for achieving financial freedom — something most of us are striving for,” explains Warren Ingram, financial planner and co-founder of Galileo Capital.

1. Developing better spending and saving habits

To build a lot of wealth and achieve a solid financial future, you’ll need to plan ahead and develop spending and saving habits. Here are a few good habits you should develop before you can build a lot of wealth starting from zero: 

Habit 1: Settle your debt

“You cannot get rich if you have short term debts such as credit cards, clothing accounts and overdrafts,” explains Ingram. He continues to say that if you really want to become wealthy, you’ll need to pay off these bad types of debt as quickly as possible. After that you can keep your good debts such as home loan and car debt. Unless you’ve inherited a large amount of money, you will most likely need a loan to buy your first car or house. This isn’t a bad thing.

“Debt can be a wonderful tool for wealth creation if you’re using it to buy assets that will appreciate in value at good growth rate,” reveals Ingram.

Habit 2: Have emergency funds at hand

Once you’ve eliminated all of your bad debit, you should start building up a cash account that is accessible at short notice, for when disaster strikes. “Try to keep 3-6 months’ worth of your monthly expenses in this account. It’s not an investment and should only be used to pay for emergencies such as a car breakdown or insurance claim,” explains Ingram.

This account will enable you to still pay for emergencies without having to sell investments at the wrong time.

Habit 3: Start saving

The earlier you start saving the better, but even if you’ve left it until later in your life, you can still benefit from compound interest. The longer your savings has access to a good interest rate, the larger the final amount will be. Starting early enables you to accrue compound interest but starting right now can also impact your financial future.

“Few people in their 20s realise how drastic the impact will be of only starting to save in their 30s. Starting to save at age 35, as opposed to 25, can chop a massive 40% off an investor’s potential retirement benefits. In fact, our research has shown that your first 10 years of investing are even more important than your last 10 years,” explains Jeanette Marais, Director of Retail Distribution and Client Service at Allan Gray.

For example

If you saved R1 000 a month for 10 years (i.e. a total contribution of R120 000), then stopped contributing but continued to invest the money for 30 years, you’d achieve the same total as someone who started 10 years later by contributed R1 000 a month for 30 years (i.e. total contributions of R360 000).

“Younger people can invest all their savings in shares because they have the time to let these investments grow,” explains Ingram. However, if you’re starting to save later in life, you haven’t missed the boat, there is still time to accumulate savings. You’ll most likely need to save a larger amount every month, as well as choosing more aggressive investment options, but the faster you start saving the brighter your future will look.

“In your lifetime as an investor,” advises Ingram, “you’re going to see many stock market crashes and recoveries, your job is to simply keep saving through all of them. Ignore all the people and pundits who will try to scare you out of saving, just keep your head down and stick to the plan. Ideally you should save as much as possible in the beginning.”

Once you have these spending habits under control you can use the money you’re saving every month to invest in your future. Here are some investment options for you to choose from.

2. Investing your savings smartly

Now that you’ve reduced your debit and are saving money every month, you can take the next step to building wealth. There is a perception that investing requires large sums of money, but the reality is many investment accounts have very low minimum monthly contributions making it possible for almost everyone to start investing.

How to invest

To become an investor you’ll be using your money to acquire assets that offer the opportunity for profitable returns. For example:

  • Interest and dividends from savings or dividend-paying stocks and bonds
  • Cash flow from businesses or real estate
  • Appreciation of value from a stock portfolio, real estate or other assets.

Why you should diversify your investment

There are of course risks associated with any type of investment, but to mitigate this risk you can diversify your investment portfolio. If you invest all your savings into the shares of a single business, you could lose all your money should that business fold.

On the other hand, if you invested in a single bond in a handful of top performers and one of them declared bankruptcy, you wouldn’t be left with nothing.

Understanding asset allocation

Another type of diversification is to ensure you invest across multiple asset classes. This is because conditions that cause one asset class to do well often lead to another to have poor or average returns. Splitting your assets across classes will balance your portfolio.

Various factors influence how you decide on what percentage to invest in each asset class, including your risk tolerance and the amount of time you can invest for.

For example: Shares are considered the riskiest and cash-like investments the least risky. Keep in mind, that the greater the risk the greater the reward, so while shares come with the highest risk, they also have the potential for the greatest returns.

Bonds are less volatile in comparison, but they also help a more modest return, with cash-like investment carrying the smallest risk, but the lowest returns.

Case Study: If you wanted reasonable returns and are comfortable taking some risk, you could choose 80% in shares, 15% in bonds and 5% in cash. Alternatively, if you had a shorter time to invest in and wanted a safer option, you would be better off with a more conservative asset allocation with a smaller percentage invested in shares and more in bonds and cash. 

Beating inflation with growth assets

It’s vital that your investments are constantly growing, to ensure they aren’t eroded by inflation. If you consider, at current inflation rates, the value of your money today could halve within 12 years. If your investments don’t at least keep up with inflation, you’ll be going backwards.

If you have 15 -20 years to grow your investments, a good option could be local and global equities. Equities is however the long game, short-term disruptions in the market can cause the share price to fluctuate. Ultimately, if you selected wisely, the share price will reflect the business’ growth in profits, which should be above inflation.

Taking the long-term view

“If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes” – Warren Buffett.

If you’ve left starting an investment portfolio till later in life you can still retire with a healthy nest egg, but you will have a vastly different strategy to someone who has 20-40 years to grow their investment.

Investments typically do require a significantly length of time to develop and grow, which is why the faster you start one the faster your money will grow. “While investing for 150 years is not realistic, backing an investment fund for ten, 20 or even 30 years is practical, particularly if you are investing into a pension for retirement,” explains Nick Train, Lindsell Train Global Equity fund manager.

“Investors should find an investment fund with a strong track record, with a manager whose style they like, invest and then leave their money alone for at least five years.” The longer you invest your money for, the more wealth you’ll build.

“There’s no single way to invest your money that’s the “right” way,” explains Ingram.  “There are plenty of ways to go about it. The bad news is that it can be difficult to decide which option you’re going to choose.”

There are some easy-to-understand options says Ingram that are low cost and will generate decent growth. A good starting point is to determine your investment goals, such as how long you have to save. The amount of time you have to save will determine which investment options are viable and which aren’t.

Here are a few of the asset classes that you can invest in:

1. Cash

Cash is a safe investment. It’s for those who don’t feel comfortable investing their money in anything else, or for those who need access to the money in a relatively short period of time. “It’s far wiser to invest your cash in a money-market or fixed-deposit account at a bank, as these are relatively safe investments,” explains Ingram.

“Make sure you ask lots of questions before signing any forms to start an investment at a bank. Some banks will get you to speak to a consultant or adviser, who will try to steer you into buying a unit trust or other products where they charge upfront commission.”

The main disadvantage to cash investments is the low overall return on investment, but if you’re looking to have a rainy-day fund or the security of being able to access your money relatively easily, then cash may be the investment option for you.

“With cash investments, you should also be especially cost conscious, as fees will eat into your returns,” advises Ingram. “Don’t make any investment where the bank charges fees for opening or adding to a money-market account. Most of the banks offer quick-access money-market accounts for which no fees are charged and that pay relatively high interest.”

The different types of cash investments

As mentioned above banks offer a variety of accounts, from the everyday savings account to call accounts, and money market accounts. You’ll need to determine which one works the best for you.

For example:

  • savings account won’t earn more than four percent a year, which could be less than inflation resulting in you losing money every year.
  • Call accounts and money market accounts will offer higher rates but require a higher initial investment.
  • A 6-month fixed deposit account will offer you a higher return compared to a 32-day flexi account as it’s invested longer. However, if you decide on the 32-day flexi account, you can have your money in just over a month, in case of emergencies.

“When markets are performing well the mantra is often ‘cash is trash’ as there are usually better returns to be had elsewhere,” says Glenn Silverman, Chief Investment Officer at Investment Solutions.

“However, when things go south there is nothing as beautiful as cash. It’s a much-maligned asset class but it provides wonderful optionality. It allows you to take advantage of a falling market by purchasing under-priced assets. If you’re fully invested and have no cash available, then you can’t take advantage of falling asset prices.”

2. Unit trusts

A unit trust pools the contributions from numerous investors, to invest in assets such as shares, bonds or property. This offers investors access to more elusive markets, while increasing your exposure to a range of assets, which are carefully selected and managed by an investment professional.

Investing in a unit trust allows you to save and increase your money with inflation. It also offers you the flexibility of withdrawing your money typically within 48 hours. On the other hand, the minimum required investment can range between R10 000 and R50 000, depending on the fund manager.

Returns can fluctuate anywhere between 6.75% and 8.12%, with charges of around 0.3% for each investment year.

The different types of unit trusts

  • Equity funds: These are the most common type of unit trust. It’s comprised of listed companies based on specific criteria determined by the mandate of the unit trust. For example: You can get equity fund unit trusts that only invest in specific sectors such as construction shares, or a specific type of share, such as large caps.
  • Balanced funds: This is a portfolio that has a mix of equities, fixed income securities and cash. These are preferred by investors who want to reduce the risk of investing in the major asset classes.
  • Fixed-Income funds: These unit trusts invest mainly in fixed-income products such as bonds and money market instruments. The aim of this fund is to provide you with a regular source of income. It’s a good option for retirees who need extra cash.
  • Index funds: This type of unit trust invests in businesses that closely match a specific index. For example, the industrial sector.
  • International equity funds: This unit trust focuses on offshore companies as opposed to local ones.
  • Money market funds: This type of fund invests in liquid, low risk money market instruments, such as treasury bills or certificates of deposit. It is an open-ended mutual fund that invests in short-term debt securities.
  • Real estate investment trusts (REITS): A REIT is a listed company or property unit that invests in immoveable property. This unit trust receives income from rental and pays it through to its investors. It buys, manages and operates the property.
  • Shariah funds: These are ethical unit trusts that invest into Shariah compliant investments. This excludes businesses involved in activities, products or services related to, for example, gambling and alcoholic beverages.

“If managing your own investments makes you a little nervous, unit trusts are a good option, or you can contact a professional financial adviser, advises Warren Ingram. “Just ensure she or he is properly qualified and accredited, and, if possible, find someone who charges by the hour, not by commission, on the investment products they sell you.”

He goes on to say that you can also invest in a money-market unit trust offered by an investment adviser, but ensure you’re not paying upfront fees. “It’s acceptable for an adviser to earn an annual fee from your unit trust (no more than 0.5% per year on money-market unit trusts), but only if the interest you earn after costs on the unit trust is as good or better than the rate offered by the bank,” advises Ingram.

3. Shares

If you’re looking at a long-term goal, then you can afford to be riskier with your investments. Instead of cash you should look at investing in shares.

“A share is the smallest unit of ownership in a company or unit trust. You can own shares in private companies, and companies that trade on the stock market,” explains Ingram.

Since there’s more risk with shares you can also expect three to four times more growth, which is why you need to invest this money for longer periods of time.

How you can invest in shares

There are several ways to invest in shares, such as:

  • Buy them directly through a stockbroker: This means that you own shares in a business that you selected yourself. “For people who are new to share investing, I generally recommend that they invest in large, well-known businesses that have been in existence for many years. These are sometimes called “blue-chip” shares,” explains Ingram.
  • Via an exchange-traded fund (ETF): If you have a smaller amount to invest, the cheapest and easiest way is through an ETF. Ingram explains that an ETF trades on the stock market like an ordinary share, but it consists of a basket of shares in various companies. This allows you to buy multiple underlying shares with one investment.
  • Through unit trusts
  • Through an endowment: You invest your money for a minimum of five years or longer. The money you take out when it matures is tax-free.
  • Through a retirement annuity: This “is basically a personal pension fund. You put away a certain amount of money each month, and when the fund matures at your retirement age, it will pay you out a monthly pension,” explains Ingram.

Even though investing in shares can seem out of reach for most, you can invest as little as R300 a month or with a R1 000 lump sum. However, you need to be aware that if you opt for the monthly option you could be charged an annual fee of up to 1%.

When buying shares, you should use your knowledge of the industry you’re in. For example, if you have worked in the manufacturing industry for many years, you might have good insights into that industry. You will still need to research the companies you’re looking at, as you need to be certain of what you’re buying.

4. Bonds

“Bonds are tradable debt instruments whereby a government, state-owned enterprise or corporate raises capital by selling bonds into the market,” explains Simon Brown is the founder and director of JustOneLap.com, independent trading company.

“These instruments have a maturity date and an interest rate (called a coupon). The maturity date will be determined by the issuers’ needs while the coupon rate will be determined by the perceived risk of the bonds, the ability of the issuer to pay the coupon and repay the principle.”

For example

You lend R1 000 to your friend. You agree that he will pay back the money after five years and will pay you 6% interest per annum. You will receive R60 a year in interest and at the end of five years, your R1 000.

If the bank savings rate is lower than the interest you’re charging, then you’re earning a high return. This is where the risk comes in, if the bank increases its interest rate to 7% then you’re losing 1% a year on your investment.

You can then sell the bond to a third person at a slightly discounted price of R950. This third person is still scoring because they’re now receiving R60 a year on only R950 (6.3%), plus he gets R1 000 at the end of five years.

On the other hand, if the reverse happens and the bank rate goes down to 4% you can sell your bond to a third person at R1 100. You’ll make an immediate R100, and the third party will be happy because he’s getting a return of 5.4%, which is better than he’d get at the bank.

Why you should invest in bonds

There are two ways to make money on bonds, namely:

  • On price: By trading them over the short term, for example, buying low and selling high.
  • On yield: This is more of a long-term investment.

Bonds are typically issued in large amounts such as R1 million making them inaccessible to most individual investors. However, institutional investors such as life assurance companies and retirement funds, use them extensively, which is why you’re probably indirectly investing in them.

“However, we have had a few local exchange-traded funds (ETFs) issued over local bonds, tracking government and inflation-linked government bonds,” reveals Brown.

“We’re now also seeing two new offshore bond ETFs coming to market. Ashburton has issued an ETF tracking the Citi World Government Bond Index (WGBI) which invests in fixed-rate, local currency, investment grade sovereign bonds from over 20 developed and emerging market countries.”

He continues by saying that South Africa is also getting a new Stanlib bond ETF tracking the “FTSE Group-of-7 (G7) Index”. This will focus on developed markets only while the former includes a small weighting of emerging-market bonds such as those belonging to South Africa.

5. Properties

Investing in property is often seen as a safe, less volatile choice as it requires a long-term approach. Although, this type of investment isn’t without risk, there could be a market or area dip, or an interest rate hike, but it’s still one of the best investment option as people always need a place to stay.

The different types of property investments

  • Primary property investment: This is the process of buying and owning your home. Numerous property buyers apply for a home loan to purchase their first home. Over time, your property should appreciate, which will put you in a favourable financial position.
  • Buy-to-let investment: This is when you purchase a property with the express intention of renting it out. To ensure ongoing profits you’ll need to determine the best area and type of property to buy, and potential tenants need to be thoroughly vetted. Once paid off the profit can increase significantly, and the property should also increase in value, putting you in a strong financial position.
  • Offshore buy-to-let investment: Investing in buy-to-let property offshore can effectively create a buffer against economic or socio-political headwinds. You can earn in a foreign, most likely stronger currency, and possibly even gain citizenship through incentive programmes. Be aware that you should employ a reliable and efficient offshore property management service to ensure the success of your property.
  • Listed property fund: Local and offshore listed property funds give investors access to the benefits of owning property without having to deal with a physical building. “It gives an individual the opportunity to invest in a range of properties through the purchase of stock. Property funds buy you a stake in real estate companies listed on the Johannesburg Stock Exchange (JSE) – saving you the headache of maintaining property and dealing with dodgy tenants,” explains Fayyaz Mottiar, Fund Manager of the Absa Property Equity Fund.

“For a small investor, a buy-to-let property comes with a concentration of risk. You are spending a huge amount of money on one single asset and if the tenant goes wrong, you take a big financial knock,” explains John Loos, household and property sector strategist at FNB Home Loans.

“Yes, the share market can be volatile, but if you bought into one listed property fund, you have already spread your risk into a number of properties, so the concentration risk isn’t nearly as much as with a buy-to-let property.”

Here are five top tips from Tony Clarke, MD of Rawson Properties:

  • “Accept that property is always a long-term investment with ups-and-downs. If you are out for a quick buck, you won’t find it in property.
  • “Set yourself the goal of building up a property portfolio which you’ll steadily expand. Don’t sell your investment property, even to buy another.
  • “Don’t rush this process. Avoid buying numerous highly bonded properties consecutively. Rather buy one, set it up nicely, before you move on to the next.
  • “Try to invest in both freehold and sectional title residential property, and small commercial and industrial units.
  • “Accept that your own home is part of your portfolio. Too often, as salaries increase, so does the desire for a bigger and better home, resulting in huge bond repayments having to be paid. Rather have a moderate home and save by having a small bond here and use the spare cash to buy elsewhere where you will earn rent.

“Property truly gives you the best of all worlds as you get to enjoy it while living there, enjoy rental income if you choose to let, the satisfaction knowing it’s yours, and only yours, once paid off, and of course the reward of knowing you have something to leave behind for your children someday,” says Craig Hutchison, CEO Engel & Völkers Southern Africa.  

3. SA Financial Experts Tips For Investing

  1. “Find a practice which is willing to invest in you now and partner with you for life. Every successful investor began their journey with one small investment,” explains Sue Torr, managing director at Crue Invest.
  2. “The way that the prosperous continue to build their wealth isn’t really a secret – they spend less than they earn, save the difference, and let the potential of compound interest make their riches grow,” says Hutchison.
  3. “UBS Wealth Management in Switzerland studied the difference in the wealth of people who are good planners versus those who are not,” explains Ingram. “It found that if you don’t budget and you don’t have investment and retirement plans, you are guaranteeing that you will limit your wealth over your lifetime. The report also shows that even a small amount of planning can make a massive difference.”
  4. “Setting these goals is like setting the destination points on your GPS – you’ll save a lot of time and money by having a clear endpoint in mind instead of coasting around,” says George Herman, Director and Chief Investment Officer at Citadel Investment Services. “Be as specific as possible, thinking carefully about how much you will need and your timeframe.”
  5. “People in their 20s don’t save or invest because they’re waiting to get a better job or start a business to earn more money, but the truth is most millennials spend 30-50% of their pay cheque on entertainment. It’s better to start putting a little aside when you have minimal responsibilities and take advantage of the power of compounding interest. You must find a balance between having fun and having funds. Sometimes It’s okay to miss out to stack up,” – Arese Ugwu, authorSmart Money Woman
  6. “Every South African knows that Cape Town property growth will be more attractive than property yields in smaller towns up-country. So geographical location must be taken into account,” says Jan Vlok, a research and investment analyst at Glacier by Sanlam.
  7. “It is a big mistake to borrow money to use for investing,” says Gusta Binikos, CEO of FNB Share Investing. “Investing is a long-term game, and nothing is certain, there is a chance that you can end up losing money and owing on your debt, leaving you in a very bad financial position.”
  8. “As South Africans, we should think more globally,” says Jean Pierre Verster, a portfolio manager at Fairtree Capital. “We shouldn’t limit ourselves to stocks listed in SA only. The ease with which South Africans can now open brokerage accounts that allow for access to stock exchanges globally reinforces this.”

By Nicole Crampton

Source: Entrepreneur Magazine

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