“Capital as such is not evil; it is its wrong use that is evil. Capital in some form or other will always be needed.” – Mahatma Gandhi
Investing is the action of promising money or capital towards an effort, with the expectation of obtaining a return, additional income or profit. Investment is significant to achieve financial goals and provides a buffer for unforeseen expenses that may arise in future. As it takes years or even decades for a seed to express itself into a tree, wealth creation is also a slow process with its own gestation period. Individuals aspiring to develop an investment portfolio for wealth need to give their portfolio sufficient time to grow into a wealth creator.
Investment Approach with Portfolios
There are various ways to invest but investing in the stock market is a great way to generate wealth over a period of time. Investing essentially refers to a long-term assurance of money as opposed to short term trading or speculating. Constructing a well-maintained portfolio is vital to any investor’s success in creating wealth. Short-term investment also comes with associated higher risk. Intelligent investing is the key to build wealth as risks are integral to it. The business in which the amount is invested may go down in value or even close down completely. It is important to research about the businesses and analyze the risk before putting in the money.
Structure of a Model Portfolio
As an individual investor, the model portfolio should meet the future needs for capital. They need to learn how to strike the right balance in asset allocation is best for personal investment goals and strategies. This is regardless of whether there are a dozen companies or a hundred in the equity portfolio they own.
The general principle for an investment is that around half of the portfolio should go for blue-chip or other well established companies. The other half should go in upcoming mid-caps stocks and the balance in small lesser known companies with high potential for growth. The stocks selected should represent a stable financial position and a well-managed balance sheet. The real challenge of building up a portfolio is to maximize earnings over the holding period. Five to ten good stocks should be held actively at any given point of time. For long term investment in stocks, considerations may be the market capitalization, CAGR, risk versus return and P/E ratio.
Risk-Return Trade Off
Risk and return are inherent components of any investment. These two factors remain always relevant irrespective of the investment in equity in the stock market, government bonds, financial instruments, and real estate. While the risk refers to the likelihood of incurring losses comparative to the investment, the return indicates the actual gain or loss generated from investment. There is no investment which is completely risk free. The risk to return tradeoff is therefore an investment principle that drives the profitability.
Asset Classes – Building Blocks of a Portfolio
There are numerous asset classes in the investment market that relates to different levels of risk and return. The general rule is that higher the return higher will be the risk. Public and corporate bonds, fixed-income securities, cash, marketable securities, equities, stocks and commodities are the most liquid asset classes. Investment in hedge funds, venture capital, crowd-sourcing or newly emerging crypto-currencies is also considered under the asset classes by some of the analysts.
There is a bucket approach which offers a modest method for distributing assets and provides psychological benefits as well. There is one occurrence that is frequently observed in the stock market that the returns from stocks vary greatly over short periods of holding. But in the long run stocks consistently beat the rate of inflation and the return from other investments.
Steps to Build the Wealth
Wealth creation is a long term process with a strategy driven by a well-crafted plan to generate returns. A little help from the professional portfolio management service providers is recommended especially if the amount is higher.
A Blueprint of Wish List – The first step in any major project is to create a wish list and it is equally important to be specific with the financial wish list. Most people have multiple items on their wish list – such as buying a house or a car, payment of kids’ college expenses, and generating income for retirement.
Prepare a Budget – The real work is in the details of the project. Investors should calculate an estimated amount required for the project. They should also determine the monthly amount that is required to be kept aside for allocation as an investment towards a short-term goal.
Diversify – Once the budget is ready the next step is the actual plan of the portfolio. Experts do not believe in a perfect allocation but various types of assets have their own qualities that are appropriate for specific goals.
Wealth Creation Process
Wealth creation has its own way of unfolding which takes variable time as the investments made previously starts accumulating returns. Even if someone suddenly gains enormous returns, there might have an equal and opposite adverse situation either at one or multiple places to compensate for the sudden rise. Therefore, the wise portfolio advisers always caution investors planning for wealth to wait and watch in a disturbed stock market.
With sufficient time, the power of compounding sustains the wealth and also multiplies it many times over. The wealth creation, portfolio advisors say, is not a process of unbroken growth over the time period and is often back-loaded in the given long-term period. The concentrated growth occurs towards the latter half of the investment period if the investors have the patience to hold on to their goals even in short-term chaos of the market. Investing money is necessary for allowing it to grow.
Minding the Life Goals
As investment grows the goal should not be profit maximization but to achieve the life goals that are decided. Major life events in investor’s life should be connected to portfolio review and possible revisions. Life events such as a job change, the birth of a child should result in revised allocation of assets. Even if there is no life-changing event, the review of the portfolio should be carried out at least once a year. The returns generated from investment are further reinvested which consequently show the compounding effect. Earning money on the money already earned is an undisputable way of creating wealth over time.
