Engineers know that for a building to remain structurally sound for many decades it must have strong foundations. It doesn’t matter how good a building is above the ground, if the foundations are substandard, the building won’t last.
The same is true for building wealth. There are several foundational matters that investors must optimise before they start investing. If they invest enough time and energy into optimising these matters, it will make the process of building wealth more successful.
Here are the matters that I consider to be foundational.
Know where you are heading
You never jump in your car and drive around aimlessly. You always decide on your destination first, and then work out the fastest route to get there. That’s exactly what you need to do when building wealth too.
Best-selling author, Stephen Covey of “Habits of Highly Effective People” book fame advises to always “begin with the end in mind”. Essentially, that means asking yourself how will money/wealth change your life? For example, is retiring completely as soon as possible your goal. If so, how much money do you need to live? Or maybe you would like the flexibility to reduce the amount of work you do. What is it you want to achieve?
My point is that you need a rough goal to aim for because it will give you a context for making decisions. In the absence of a goal, it is very difficult to work out what steps you should take – just like you cannot work out the quickest route without first knowing your destination.
Whilst it might seem like an obvious point, my advice is to set lifestyle goals, so you are better able to formulate an investment strategy.
You’ll make costly mistakes if you try to do it all yourself
I typically like to solve problems by asking myself ‘who should I speak to’ not, ‘what should I do’. This approach forces you to think about who you know that might have more experience solving the problem than you do. This helps you benefit from other people’s mistakes, and not making your own, which can be costly.
Knowledge is very important and valuable. But knowledge without the experience of how and when to apply that knowledge can be dangerous because you’ll inevitably make mistakes. Investing mistakes can be costly. At worst, you’ll lose money. At best, you’ll waste time – and time you can never earn back.
Warren Buffett says that “risk comes from not knowing what you’re doing.” Therefore, if you want to reduce your investment risk, you must build a trusted team around you that has a lot of experience in helping people achieve what they want to achieve. That team might include a good financial advisor, mortgage broker, tax advisor, property buyers’ agent and lawyer. Depending on your situation, you might not need all these professionals now, but you probably will eventually.
Depending on the complexity of your situation, you may benefit greatly from engaging with a holistic team. I’m working on developing a strategy for a client at the moment that involves several tax planning opportunities. In my opinion, it would be impossible to formulate the most efficient strategy if I wasn’t able to workshop ideas with the client’s accountant, which I can do, because we work in the same firm.
You can’t build wealth if you spend all your income
I know it’s a boring topic, but cash flow management is very critical. There are two things you must achieve.
Firstly, you must eliminate costly unconscious expenditure. That is, spending money on things that add very little enjoyment. That is a waste. Good cash flow management is not about eliminating or minimising expenditure. If you love going to fine dining restaurants, then do that, because it gives you a lot of enjoyment. But if you don’t care whether you buy a takeaway coffee or make one at work/home, then stop wasting $6 on each coffee!
Secondly, you must spend less than you earn so that you have some money each fortnight or month to contribute towards building wealth. You cannot expect to be able to build wealth if you do not have surplus investable cash flow. If you don’t have any surplus cash flow then you either need to find a way to increase your income or reduce your spending, or both.
I set out a very simple and easy way to eliminate unconscious expenditure here.
Set a target, even a rough one
A goal is something that is measurable that you have a plan to achieve. If you haven’t set a specific target then it’s really just a dream, not a goal.
Most people don’t know how to set a retirement goal, so let me help you by giving you a general explanation – a rough rule of thumb if you like.
Firstly, you must know when you would like to retire and how much you need for living expenses. You can access super at age 60, so this tends to be a common age target. And in the absence of a more considered living expense number, most people would spend in the range of $80k to $100k to enjoy a comfortable retirement excluding expensive holidays.
Secondly, you must estimate how much net wealth (i.e., the net value of all property, super and shares not including your home) you need to be able to fund living expenses almost indefinitely. To do that, multiple your annual income target by 18. Therefore, if your goal is to have $100k p.a., then you need $1.8 million of net investment assets which allows for an average future investment return of circa 7% p.a. and allowing for a small amount of tax.
Of course, this is only a rule of thumb. But it’s better to have a goal, even if it’s a rough one, especially if you are at the beginning of your investment journey.
Clearly understand your investment philosophy
Probably one of the most important steps is to develop an investment philosophy. An investment philosophy is what you believe about how to build wealth and will guide your investment decision making.
For example, I believe that building wealth takes time. It’s silly to take high risks if you can earn an annual return of 7% or more by playing it safe (noting an investment return of more than 7.2% p.a. will see the value of your investments double every 10 years, which is probably enough to meet your goals). Following an evidence-based approach gives you the highest probability of achieving your goals – there’s no need to throw darts at dartboards. Shortcuts rarely work and are often a futile distraction. Beliefs such as these shape your philosophy. I’ve shared more about my philosophy here.
Adopting some clear financial beliefs will help you stop making mistakes, getting distracted by short term noise and avoid advisors that aren’t aligned with your way of thinking.
Most people rush into investing
If you do these things before you begin your investment journey, or as soon as possible if you have already started, it will put you miles in front of most investors. These steps are relatively simple and logical but absolutely fundamental to maximise the likelihood that you will build wealth successfully.
