5 step guide to building wealth

          In today's information age, we are bombarded with so much information and different strategies, especially in terms of wealth creation that it becomes harder and harder to decide which option to undertake.

Often it is a simple matter of deciphering the vast amount of information that is available and formulating a strategy that is suitable to your circumstances.  As one of my colleagues likes to say, the availability of information today   is like drinking out of a fire hydrant.  What you need is someone or some mechanism to help you reduce the flow of information so that it can be processed better.

Often, it is far easier and faster to engage the services of professionals that specialize in the area in which you want to invest.  These professionals need to be people who are actually doing the stuff rather than just advising. This means that they must have a track record of being successful themselves and be actively investing in say, property or   if it is shares they are advising on, then in shares.

This helps to decipher the vast amount of information that is available, and for these professionals to help you start a portfolio, so that you can start creating wealth immediately. When consulting, I am amazed at the number of people who have been thinking about investing for the last eight to 10 years but do not have the knowledge or the information on how to get started.  They know all about how to invest, what’s involved, and that they do need to invest, yet for some reason they don't get started and when questioned closely, they mention that they get confused with vast amount of information available to them or that they do not have the time to do the research to find a property that is suitable.

This is where the engaging of a property advocate, together with a wealth creation specialist could work wonders.  I have helped people get the initial momentum to start moving forward in their investing, simply by putting the right team together for them so that they can leverage their time. These professionals   do this on a full-time basis, and therefore know where to look and what to look for and would be able to find properties that fit your strategy so that your goals are achieved.

Ask yourself, how long you have wanted to invest.  How long have you known that you must invest in order to provide for yourselves in the later years?  Perhaps it is time now to become serious about investing, especially as we approach the end of the financial year.

If you plan it right, and seek the right help, you can then start off the new financial year with a new investment program that will then ensure that you are cared for in your later years. 

Source: Victor K.

Step 1: What's right for me?

What you'll learn in this step: Diversifying your investments reduces your risk.

Making the move from saver to investor is your first step on the road to building wealth. It's only by putting your money to work that you can really get ahead. There are five basic categories of investments: Australian shares, international shares, property, fixed interest, and cash. These are often referred to as asset classes. Within each asset class you can diversify further. For example, within Australian shares you can choose industrial blue chip or resource stocks. The idea is that the more widely you spread your investments across and within these classes, the more you reduce your risk.

It is possible to over-diversify if you have lots of small amounts invested in too many shares. Any price increase would have a negligible effect on your total portfolio. Under-diversification occurs when you have too much money invested in too few shares or only in a particular industry.

Rebalancing your portfolio

Rebalancing your portfolio occurs when you decide to change the amounts you have invested in each asset class. For example, you may have started your investment portfolio with 30 per cent invested in shares, 30 per cent in property, 30 per cent in fixed interest and 10 per cent in cash. One year down the track with a booming sharemarket, you may now have 40 per cent invested in shares, 25 per cent in property, 20 per cent in fixed interest and 15 per cent in cash.

This heavy weighting towards shares may not sit comfortably with your overall strategy. You may wish to rebalance your portfolio by selling some of your shares and diverting those funds into property and fixed interest. This usually means you are selling shares when they are at a high price which is not necessarily a bad thing as you're taking a profit, and buying into property at a lower price.

Asset allocation

Which assets you invest in and how much you invest in each, is determined by your personality, age, goals and your stage of life. It's what the experts call your risk tolerance.

Everybody is different. If you want to know your money is safe at all times, you are probably too nervous to invest too much in the sharemarket. However, if you like to take a few risks, then only investing in fixed interest investments would be too boring.

The weighting you give to each investment will depend on your circumstances and risk tolerance. What it comes down to is working out the right mixture of shares, property, fixed interest, and cash for your personal risk profile. Depending on your stage of life, you should end up with a combination of growth and income assets.

Step 2: Know yourself

What you'll learn in this step: Understand your personal risk profile by working through our investment checklist.

When you meet with a financial planner or go online to one of the many financial supermarket sites, you will usually have to complete a questionnaire that helps determine your risk profile. Once you know what type of investor you are, you are able to make more informed decisions about your investment choices.

However, your risk profile is only part of the equation. You also need to understand what it is you want to achieve. This could be the level of income you want for retirement or how much you need for school fees. Once you know this, you can work backwards to find out what you need to do to achieve those goals. Usually there have to be some trade-offs. If the amount you require is high relative to the amount of time you have before you want it, then you may have to increase your exposure to risk or revisit your financial goals.

Investment checklist

In determining your mix of investments, ask yourself some key questions:

• What are your goals?
• What is your investment horizon?
• Do you want income or growth?
• How would you cope if the value of your investments fell?
• What are the tax considerations?

What are your goals?

Are you looking to invest for the short term, maybe to fund your children's education or buy a car? Or are you hoping to build wealth for your retirement in 20 years' time? Maybe you want an investment that gives you a regular income now. Your goals will determine your investment horizon.

The longer your time horizon, the more risks you can afford to take. A slump on the sharemarket tomorrow may not have much impact on the value of your investment in 10 years, but if you're looking to cash in your investments in a couple of months, there may not be enough time to recover your loss.

Income versus growth

The type of investments you choose will depend on whether you want capital growth for the future, an income now or a combination of the two. If you want to receive income on a regular basis, then there's no point in investing in speculative shares that don't pay dividends. Property trusts, fixed interest or high-yielding shares are a better alternative.

Alternately, if you want to build up your assets and don't require an income from them, high-yield investments are not for you, especially as in many cases, you would lose half of that income in tax.

What if your investments lost their value?

Say you invested $10,000 in the sharemarket and following a slump it was now worth $4000. What would be your reaction? If such a scenario makes you nervous, you are probably better off investing in more conservative investments that won't keep you awake at night.

But don't think that putting your money in the bank is the only solution. Any interest you earn

would soon be eroded by inflation. Fixed interest securities or bond trusts are more conservative than shares but provide growth.

Step 3: Seeking advice

What you'll learn in this step: How to choose a financial adviser.

We are all leading increasingly busy lives and with the growing range of investments on the market, sometimes it is just too hard to try and determine which ones are best for you. This is where the guidance of a financial adviser should be sought. He or she can determine your investment needs and create a plan that can help you attain your goals. But take care when choosing one. The industry watch dog, the Australian Securities and Investments Commission, in conjunction with the Financial Planning Association, has published a booklet called Don't Kiss Your Money Goodbye, which provides tips on selecting an adviser.

You need to research your financial adviser almost as thoroughly as you would research your investments. Certainly, don't just settle for the first name you are given, even if it comes highly recommended by a friend – your needs could be different to theirs. Arrange a consultation with two or three, and compare how they operate. It's important that you find out how they make their money. Do they charge a fee for consultations or do they receive a commission from the products they recommend? The former style is more likely to lead to you being given advice that is independent. Many advisers charge to draw you up a plan and then charge a percentage – maybe between 1-2 per cent – based on the assets under management.

Questions to ask

• Are you licensed?
• What is your previous experience?
• What are your qualifications?
• How do you earn your money?
• Are you linked to a particular finance house?
• What do I do if I have a complaint?

Questions to answer

A financial planner needs to know about you and your goals before they can structure a portfolio for you. You need to go prepared to discuss all aspects of your situation – both personal and financial including marital status, children, your investments including superannuation, and your goals. If the planner tries to sell you a product at your first meeting, think twice, as they're probably more of a salesman than an adviser.

Step 4: Tracking your tax

What you'll learn in this step: An understanding of tax and how to minimise what you have to pay.

When it comes to structuring your affairs, there are a number of steps you can take to minimise your tax liabilities. These include income splitting, timing of buying and selling your investments, negative gearing, using capital losses to offset gains and taking advantage of the superannuation environment. One thing to consider if you are paying the top marginal tax rate, is to aim for investments that offer high capital growth rather than an ongoing income as nearly half of any additional income is lost to tax.

Income splitting

If you have a non-working partner or they are on a lower income than you, it can be a useful strategy to divert some of your investment income into their name. That way you reduce your family's tax liability. While you can divert income into a child's name this is not a good strategy as after their income exceeds $416 they are liable to pay tax at the rate of 66 per cent until it reaches $1,446 where they pay 47 per cent on the entire income.

Capital gains tax

Most capital gains or capital losses are made from the disposal of an asset that is subject to capital gains tax, such as land and buildings, shares in a company or units in a unit trust. Other lesser-known assets include contractual rights, options, foreign currency, leases, licences and goodwill.

A capital gain or capital loss is the difference between the sale proceeds you receive for an asset and its purchase price.

Changes to capital gains tax now mean you if you buy an investment from 1 October 1999, you only pay tax on half your capital gains if you hold it for more than 12 months.

Investments bought between 19 September 1985 and 30 September 1999 and disposed of after a year, can have their capital gains tax calculated under the new regime or using the full inflation indexed gains but with inflation indexation frozen as at 30 September 1999.

If investments are sold for a capital gain before a year has elapsed, the tax will be assessed on their total gain without any allowance for inflation and will be taxed at your full marginal tax rate.

Offsetting capital losses

Of course not all your investments will reap you a profit. If you have lost money on an investment, consider selling it before June 30 and offsetting the loss against any gains made from the sale of another investment made during that financial year. Capital losses can only be offset against capital gains, not against any other income.

With investments, you either pay tax on the income or the gain received, or the tax has already been paid by the organisation you've invested in. Depending on the amount of tax paid on your behalf, you could have very little or no tax to pay.

Gearing and negative gearing

Gearing is when you borrow money to invest. It might be for a property or for shares. Gearing allows you to increase your investment and potentially get a higher return, on the downside however if the investment doesn't pay off you stand to lose more.

Negative gearing is when the interest you pay on your borrowing is greater than the income from your investment, you can claim this difference against your tax. But that doesn't mean all negative gearing is a good investment strategy. You may get a tax break, but it is still costing you money. People negatively gear because they think they will eventually sell the investment for more than they bought it for but the risks are that the value of the asset will fall; the interest on your loan will rise; or you are unable to keep making the interest payments.

Think twice about borrowing against your home, particularly for a speculative investment as you could find yourself without a roof over your head.

Margin lending

Margin lending means borrowing to invest. Investing a combination of savings and borrowed funds allows you to invest more, increasing the potential returns compared to investing savings only. In the same way as property investors will put down a 20-30 per cent deposit and borrow the rest, margin lending allows you to buy a significant share or managed fund portfolio with as little as a 20 per cent deposit. This approach is also known as ‘gearing’.

The negative side is when share prices fall below a certain level and a margin call is made, borrowers generally have 24 hours to respond in one of three ways to restore their loan-to-valuation level: come up with more cash, sell underlying assets or provide additional assets to top up their equity.

If borrowers fail to act in time, the lender will sell some of the underlying assets and the borrower has no say in which assets are sold.

Crunching gears

If you have a margin loan, make sure you are aware of - and understand - all the terms of your loan, then bone up on these survival tips:

• Regularly review your ability to make interest payments in addition to any margin calls that may arise.
• Monitor your underlying investment portfolio.
• Do not borrow to your limit.
• Keep your gearing level at 50 per cent or less.
• Diversify your portfolio across sectors of the market, fund managers and management styles such as value, growth and index.
• Pay your loan interest regularly.
• Reinvest all dividends/distributions to reduce the size of the loan.
• If you are thinking of taking out a margin loan ask your financial adviser to explain:
• The circumstances under which a margin call may be made.
• How you might respond to a margin call.
• The risk of negative equity where the amount you borrow exceeds the value of the underlying equity.
• The tax implications of margin lending.
• The relative advantages of fixed and floating interest rates, including any "break" fees if your fixed-rate loan is terminated early. Sources: ASIC/BT Margin Lending

Superannuation

Superannuation is still one of the most tax effective way of accumulating wealth. Investment earnings in super funds are taxed at the concessional rate of 15% which is far less than the marginal tax rate payable on other investments. However, it is not sensible to invest all your money within the superannuation environment. Because super is so heavily regulated, you might find the rules change over time. Also once you've invested in super, your money is tied up until you are well into your 50s. If you are only in your 20s, you will probably need to access a lump sum at some stage. It's best to keep some of your money in more liquid assets that are more easily realised.

Investment advice deductions

Money spent on obtaining investment advice can generally be claimed against your tax. Portfolio management costs, ongoing financial advice (although not your initial consultation), investment computer software and in some cases subscription to newsletters can all be claimed.

Step 5: Watch your back

What you'll learn in this step: The questions to ask to avoid being taken for a ride.

Successful investments, or ones that are most likely to make you money come down to quality.

Be wary of properties carrying rental guarantees that are sold on a lease-back basis. It may be a sign of a weak leasing market.

High returns equals high risk

The Australian Securities and Investment Commission (ASIC) warns that any scheme offering more than 2 per cent above what the banks are willing to pay on a term deposit should be treated with extreme caution. See the ASIC consumer site, Fido for the latest consumer alerts.

Do your research

It's your money you are investing, so make sure the advice you receive is sound. Is the person offering the scheme licensed and authorised to give advice? If there is a prospectus, read it. Don't get carried awaywith the spiel of a slick salesperson. Ask questions such as:

• When will you receive your money?
• Can you get your money back at any time?
• What are earnings forecasts based on?
• What commission does the salesperson earn?
• What management fees will you be paying?

Source: Money Manager