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NEWS - PLANNING
Accumulating wealth
11/14/2003
Unless you inherit or marry money, or are incredibly lucky playing games of chance, there is only one sure-fire formula for becoming financially wealthy - or at least financially secure. It starts with a conscious decision to implement a savings discipline where you spend less than you earn.
This is then combined with choosing a realistic and sustainable investment strategy, where the performance of your savings is enhanced over time and without the pressure of taking abnormal risks with your money.
While some financial wizards may advocate easier ways to achieve financial wealth in less time - by making smart investments during a property or sharemarket boom, for instance - the fortunes they make by selling their ideas generally exceed the success the majority of their disciples enjoy from following their suggestions.
The financial marketplace is awash with ideas for making money, acknowledges Arun Abey, executive chairman of Sydney- based investment management company ipac securities.
Abey, co-author of the book Fortune Strategy, which offers readers information on how they can take charge of their financial future, says most of the smart investment strategies promoted these days as a quick way of making money invariably involve an element of gearing, either visible or hidden. Although gearing can offer a high reward strategy, it is also a higher risk strategy.
But even gearing strategies require underlying financial substance - either the income to pay the interest on loans; the capital to make the initial investments; or the capital assets to offer as security where this may be requested.
Then there is the underlying investment which must be sound and priced correctly. No amount of gearing can compensate for an overpriced investment.
While there is a plethora of investments that can be pursued through such structures as managed funds, trusts, superannuation and savings plans, and strategies like margin lending, dividend reinvesting and dollar-cost averaging, you can't escape the fact that savings must first be accumulated in order to make investments.
Abey considers saving to be more important than investing. While committing your money to sound investments is certainly very important - just as essential as not being a reckless investor - accumulating the initial savings necessary to make investments is fundamental.
"To use the analogy of cake and icing, the savings are the cake from your earnings. The returns that investing these savings can achieve is what produces the icing," says Abey.
This icing can be thick or thin and over the long term it can become pretty thick. Abey says there are, however, some investors who just look for the icing and don't realise that achieving financial wealth requires substance.
Most investment ideas are for people with money, agrees Thomas Murphy, head of investment research in the private wealth management division of Deutsche Bank in Sydney. While saving is still the basis of wealth accumulation, what is changing are the ways people are accumulating savings.
There is a greater willingness to use different savings accumulation vehicles, such as managed funds and savings plans. Bank and blue-chip shares that pay good dividends and offer dividend reinvestment opportunities have been another form of savings.
The most successful investors of any age that he has observed, says Murphy, are those who follow a disciplined savings process. They make regular investments in funds or more conservative investments, and try to do so whether times are good times or bad. The other vehicle that gets similar attention is superannuation, which encourages regular savings in the form of contributions.
Another change is the attitude towards the family home, says Murphy. "There is increasing willingness to not focus your entire wealth on a family home," he says. "People are either actively using the equity in their home or not concentrating all their efforts on their home," he says. They are consciously diversifying their savings.
Robert Keavney, chief executive of financial planner Centrestone, provides another perspective. From his experience, he says, when people decide to invest they are initially very focused on what investment assets they should have their money in.
"They believe that being in the right investments is the way to financial wealth and security," he says.
But that's not the most important fundamental, he reckons. "The first fundamental is that you have the capacity to spend less than you earn by a sufficient margin in order to be able to save for what you need," he emphasises.
How much you need to save will be determined as much by your investment goals as by the ability of your savings to earn a realistic, and sustainable return.
Keavney says most people who consult him want financial security, although initially they often need some guidance on exactly what this means.
That's because the definition of financial security will vary considerably according to someone's goals, such as saving for retirement.
Keavney uses a rule of thumb method to provide a clearer focus on what financial security can involve in the way of accumulated savings. He asks clients what their current standard of living costs them in after-tax dollars.
He then multiplies this by 15, which gives a broad guide to the capital needed at retirement to support this lifestyle for the 30 years that many people are nowadays likely to spend in retirement.
"This method assumes that in retirement you will live for 30 years and die on the day your last dollar is spent," he says. If your after-tax retirement income needs are $50,000 a year, this will require accumulated savings of at least $750,000.
For most people, this exercise is a real eye opener and certainly stimulates some thought, says Keavney.
"A person who plans to retire at 70 might say that 30 years is too long. Those who are contemplating early retirement, say at 55, will often regard this period as too short," he says. But the purpose is to give an indication of the savings needed to fund retirement. He says the resulting amount is usually much more than people have saved, or are on track to save, at the rate they are going.
Adelaide actuary Peter Crump, of financial planning and superannuation advisers Portfolio Planning Solutions, says there is a mathematical basis for the rule of 15. A 30-year annuity paid annually from accumulated savings that generate a 5per cent investment return requires a lump sum of about 15.4 times the annuity payment at the outset.
Reproduced from the Australian Financial Review - Nov 14 2003
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