Wealth creation is the process by which your net worth increases over time. Using your financial resources to make wise investments will ensure your ability to create wealth in the long term.
Knowing how and where to allocate your precious resources to ensure your money is working for you is one of the most important areas to master when it comes to accumulating wealth.
Aside from the financial planning needed to become a high-net-worth-individual, having the right mindset can guide you in making the best choices with regard to your money. This article will help you to adjust your thinking so you can make smart decisions that will help you meet your wealth-creation goals.
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Invest in What You Know
From tech start-ups to pharmaceuticals, beverages to Bitcoin, the vast array of investment options can be overwhelming and it is all too tempting to put your money into an area which promises to be the next big thing.
Whether it’s an attempt to diversify their portfolio, increase their appetite for risk or simply have a stake in an exciting new venture, many investors put their money into areas they know little to nothing about. However, this is where caution is warranted.
One of the things that set successful investors such as Warren Buffett apart from the rest is their advice to only invest in what you know. The more insight you have into a sector the more capable you are to understand the pitfalls and obstacles it may encounter helping you to make informed predictions about its potential for growth in the future. With unfamiliar or particularly complex investments you are less likely to see the bigger picture and factors that can impact earnings.
Before investing in a business it’s important to understand how they make their money and have a basic grasp on their operating practices, competitors and business model. Investing in areas that you are interested in and have a passion for can help you in the long run. This is known as your ‘circle of competence’ and is a proven way to focus your investment strategy only in those areas you know best.
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Having a long-term mindset is another essential strategy for building your wealth. This approach assumes that successful businesses will increase their value over time and those investors who are patient enough to invest in the long-term will benefit from high returns.
Historically, investors experience higher rates of return over the longer term. Based on market data over the last 47 years, the S&P 500 only incurred losses in 11 of those years highlighting the volatile nature of the stock market during shorter time periods.
Adopting a buy and hold strategy will allow you to avoid short-term fluctuations in the market which are often volatile and unpredictable, and instead, focus on long-term fundamentals such as annual returns as well as enjoy the power of compounding interest.
To create wealth over the long term it’s important to understand the compounding effect of interest on your investments. Compound interest ensures the money you have invested will grow exponentially over time as it sees you earn interest on top of interest as well as on your original principal. In the long term, this method of investing will lead to substantial growth and even a small initial investment can result in large gains over a longer time horizon.
In the long-term, this mentality can help you to maintain a relatively stable portfolio that can outperform more actively managed portfolios that see their returns diminish by commission fees and taxes. Another reason it pays to be patient is the potential to defer capital gains tax on assets that have been held for longer periods.
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Decipher Noise From News
As an investor, it is easy to be bombarded with an endless stream of financial predictions, conversations and speculation that enters your inbox or appears on the news. Learning to be selective about the information you consume will help you decipher which voices to heed and which to ignore.
Some less credible sources deliberately spread rumors to artificially inflate the price of a stock they have a vested interest in only to sell it and make a profit while financial news outlets often exaggerate issues to create a buzz that has no bearing on the fundamentals of a business.
Rather than relying on what others are saying it is best to review the fundamentals of a company regularly as the stock prices will always be a reflection of this. This will give you an insight into the financial health of the company and includes factors such as the company’s cash flow, return on assets and profitability.
Unless there are any factors that could result in changes to the fundamentals of a company it is safe to ignore any short term noises that surround a stock and hold on to your investment for the long term. Reviewing the fundamentals of a company is also advisable when investing in a new stock rather than relying solely on outside sources. Below are some of the fundamentals to consider when investing in a company:
- How has the company performed historically? Companies that have a consistent and positive return on equity (ROE) over a number of years are preferable to those that have performed well over shorter periods.
- How much debt does the company have? A large debt to equity ratio indicates that more of its earnings go towards paying off debt.
- Does it have good profit margins?
- How unique are its products? This will make it more competitive in the market and increase barriers to entry.
- How much of a discount are the company’s shares trading at? This will allow you to spot undervalued companies with future earnings potential.
As this article has shown, wealth creation is a gradual process that occurs over time. Adjusting your mindset with the tips above can help you make better investment decisions, persevere through challenging times and be patient in the long term allowing you to realize large gains.
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