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A regular savings plan is the key to any wealth creation.
Understanding how much you are able to set aside each week is the first step in your investment journey and is something many people struggle with.
Importantly, once you have a savings plan in place, you need to start thinking about what you are going to do with those savings to start building some wealth for your future.
A budget is the simplest and most effective method used to take control of your finances. Simply put a budget is used to measure your income against your outgoings to determine whether you have a balanced budget, a surplus budget or a deficit budget.
The most important thing about setting up a budget is to be realistic and set goals you know you’re going to stick to. The frequency of your outgoings won’t always be the same so it’s important for your budget to measure the most common intervals; weekly, fortnightly, monthly, quarterly and annually. Most of your outgoings can be calculated fairly accurately into of these frequencies.
A few things to remember:
You must go back and check what you actually spent vs. what was in your budget and hold yourself accountable.
The budget doesn’t have to be perfect, and you may not stick to it 100% of the time. But just like a diet, small improvements over time will yield results.
Make sure your budget is written, reviewed and updated – be active about it.
Compounding interest may be the single most powerful tool you can take advantage of with your savings.
Compounding interest, when talking about investing, is when interest is paid on your principal (being the original sum of money invested) and then interest is also paid on the interest you have earned; i.e. it compounds.
A simple example to help make this clear:
You invest $10,000 today with 8% interest paid each year
Therefore, you will make $800 interest in year 1
For the next 12 months you will make 8% on the $10,800 (being the principal plus the interest)
Therefore, you will make $864 interest in year 2
And so on, for as long as your money is invested at this rate.
Each year that the investment grows, the more interest it will accumulate, through compounding. In the above example, by 10 years the initial investment of $10,000 would have more than doubled.
The final key to compounding interest is having a regular savings and investment plan.
So using the above example, but rather than just investing $10,000 and leaving it, let’s assume you are able to invest an extra $10,000 each year from your savings.
You invest $10,000 today at 8% per annum
Therefore, you will make $800 interest in year 1
You deposit another $10,000
For the next 12 months you will make 8% on $20,800
Therefore, you will make $1,664 interest in year 2
If you allow this arrangement to run for 20 years your investment would now be worth $504,229. The most amazing part about this is that only $210,000 was invested through your deposits – however you would have made an incredible $294,000 in additional value, from compounding interest.
The key to increasing the value of savings and investments with compounding interest is time, which means there is quite literally a cost to delaying your savings.
Put simply, risk is a chance that your investments don’t perform as well as you expected or worse, they decline in value. Investing in anything carries with it some risks. The frequency and severity of those risks is up to you.
There are many technical ways to help manage your risk such as diversification, however understanding what type of investor you are is the first step to making appropriate decisions about your investments.
Generally speaking, if you have more than 7 years until you will need to access the funds you are investing, then you are considered a long-term investor. Long-term investors are typically more focused on growing their capital and therefore tend to invest in a higher proportion of growth assets, such as shares.
If the money you are investing is likely to be accessed within a few years, your main goal should be preserving your capital. This includes preserving it against erosion through inflation and usually means investing in low risk options and receiving a lower return.
There are a number of different risk profiles which will influence your asset allocation and it is important that you consider all factors when determining your risk profile.
General Advice Warning
This information may be regarded as general advice. That is, your personal objectives, needs or financial situations were not taken into account when preparing this information. Accordingly, you should consider the appropriateness of any general advice provided as part of this information, having regard to your own objectives, financial situation and needs.
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