Article from http://www.stuff.co.nz/business/money
Posted on Last updated 08:15 05/05/2014
There are two paths to wealth creation - one based on using your own financial resources and the other based on borrowing money to invest.
It is not a good idea to borrow money to invest until such time as you have mastered the art of creating wealth with your own financial resources.
After all, if you can't manage your own money properly, how can you manage someone else's? There is a very simple formula for creating wealth using your own financial resources. Whether you are a risk-taking entrepreneur or a would-be saver, this simple formula applies to you. It comprises eight steps which are not necessarily taken one after the other.
The order of the steps represents their priority and the emphasis that should be given to them when planning how to use surplus cash.
1: Spend less than you earn
Spending less than you earn is all about creating a surplus which is then applied to Steps Two to Eight. The bigger the surplus, the more wealth you are likely to create. Unfortunately, the first step is where most people stumble. Once you've cracked it, the rest is relatively easy. Spending less than you earn is a matter of mindset. The easiest way to do it is to use the "pay yourself first" principle and set aside money each payday into a savings account by automatic transfer.
2: Join KiwiSaver
Your first priority with the surplus cash created in Step One is to join KiwiSaver or another subsidised superannuation scheme, if you have not already done so. Employer subsidies and tax credits mean that you will achieve a high rate of return on your money with a high level of certainty.
3: Pay off short-term debt
Paying off debt gives a tax-paid rate of return on your money which is the equivalent of the rate of interest on the debt. The higher the rate of the interest, the better off you will be by getting rid of the debt.
If you have several debts there are two schools of thought as to how they should be paid off.
Strictly speaking, you should start with the debt with the highest interest rate, but the alternative view is to start with the smallest debt so as to quickly get a feeling of success.
4: Set up an emergency fund
The best way to avoid getting into debt is to set up an emergency fund to cover unexpected loss of income through illness or job loss, or unexpected expenses such as car repairs, whiteware replacement or medical and dental bills. This should ideally be the equivalent of around three months' living expenses. If you have a mortgage, you may be able to use an offset arrangement with your bank whereby the amount of your savings is offset against your mortgage for interest calculation purposes.
5: Buy at least one house
By the time you retire, you will be financially better off if you have a mortgage-free home to live in. The sooner you can achieve this goal the better. If you are not ready to settle down in one place yet, or can't afford to buy in the area where you want to live, then consider buying a house that you rent to someone else.
6: Pay off your mortgage
Paying off your mortgage gives you a guaranteed, tax-paid rate of return on your "investment" equivalent to the rate of interest on your mortgage. If you have surplus cash of your own, it makes sense to place a higher priority on paying off your mortgage than on using this cash to set up an investment portfolio for which the returns carry risk, unless of course you are investing in KiwiSaver or a subsidised superannuation scheme.
7: Set up a savings and investment portfolio
Saving for your retirement should become a priority once your mortgage is paid off. However, not all of your saving and investing should be focused on these two objectives or you may have a very boring life!
Have two streams of saving; one for retirement and one for your shorter-term goals such as travel or home renovations. Working out how much you will need for your retirement will help you achieve balance between the two.
8: Protect your wealth
It is easy to overlook the risk of losing the wealth you have created. Risks include loss of income through illness, loss of assets through disasters such as fire or theft, relationship property claims and business failures, to name a few. Insurance brokers and solicitors can help you identify the risks you face and give you options for dealing with them.
Creating wealth takes time and it doesn't always happen smoothly. Life goes in cycles and your wealth may well ebb and flow over time as your circumstances change. The most important things to remember are to find ways to create surplus cash.
Liz Koh is an authorised financial adviser and author of Your Money Personality; Unlock the Secret to a Rich and Happy Life, Awa Press, 2008. The advice given here is general and does not constitute specific advice to any person. A disclosure statement can be obtained free by calling 0800 273 847.
LIZ KOH
Article from http://www.stuff.co.nz/business/money
Posted on Last updated 08:15 05/05/2014
