The common mantra "save, save, save" doesn't tell the whole story of building wealth. It's the growth of your assets, outpacing your debts, that creates real wealth. In this post, we delve into strategies that balance risk and reward.
Building wealth is more about smart investment than just tightening your belt on expenses. While cutting back on unnecessary spending is a good practice, it only gets you so far. The real growth happens when you transition from saving to investing.
For starters, there's a limit to how much you can save by cutting costs. At the end of the day, your same salary still needs to cover your rent or mortgage, utilities, and basic necessities like food, transportation, and clothing. You can scale back by preparing pasta at home, instead of heading to your favorite Italian restaurant to celebrate the end of the workweek.
But imagine if, instead of just keeping the money you saved from not dining out, you made your money work for you. Read here for more on this. Stashing your cash under the mattress might seem safe, but it won't increase in value. In fact, when you consider inflation, you're likely losing purchasing power over time. Consider saving for a high-end laptop by hiding money away at home. By the time you've saved enough, you might discover that the laptop's price has increased, or newer, more expensive models have been released, putting it out of reach again.
If, instead of squirreling your cash away in a piggy bank, you invest it into a stock or a mutual fund, that investment has the potential to grow exponentially from one year to the next, far outpacing the amount you would have saved by merely cutting back on expenses and stashing your savings.
There's no ceiling to how much your investments can grow. To truly build wealth, you need to make the money you've saved work for you, even though this introduces risk and requires patience. Investing your savings in the stock market or real estate, for example, might seem daunting due to the potential for loss. However, history shows that despite short-term volatility, investments tend to grow over the long term. The key is to start small, educate yourself, and stay committed to your financial goals, allowing your investments the time they need to mature and grow.
There’s no time like the present.
Life happens and unexpected expenses always crop up when you least expect them. You finally brought home a bonus? Murphy’s Law says your car’s fan belt will blow that same weekend, just as you’re finally feeling ready to take the leap and put a down payment on your first home. You may feel fewer butterflies signing on the dotted line if you’re not stretching yourself to your financial limit.
When you take leaps in life, there’s always bound to be some risk. The foundation of safely navigating these risks is having a financial cushion. This cushion isn't just about being ready for emergencies—it's about enabling your money to work without the need for immediate access.
Let’s go back to the example of the down payment. You might not be buying the home for personal use. Maybe you want to buy an investment property, and rent it out a-la Airbnb. What happens if one month is slow, with few to no bookings? What about if a water pipe blows, forcing you to cancel on guests, in order to spend even more money on repairs? What if this investment means you can't afford necessary car repairs while you get the apartment visitor-ready, risking your job? Well, then your cushion simply isn't adequate.
You need to have enough money saved so you're ready for unexpected events. But it's more than just having an emergency fund. It's also about having the freedom to invest in opportunities that come your way, all without putting your finances at risk.
Once you're comfortable with the idea of your money being tied up in investments, it's time to explore how to accelerate wealth growth. You can either invest using only your available funds or take on debt to potentially enhance returns. For instance, with $100,000 (in addition to your cushion!), you could buy a property outright or leverage that money with a mortgage to invest in a $500,000 property.
Owning a more expensive property or multiple units could significantly increase your rental income, since you’re now the owner of a more valuable asset or several units. But, with greater potential returns comes the added responsibility of managing a mortgage. The key here is balancing the potential for higher returns against the risk of increased debt.
Reducing your debts has a dual effect. Paying off debt means you're not just eliminating the recurring interest payments but also freeing yourself from the financial and psychological burden it carries. For instance, if you own a property without a mortgage, you won't have the stress of monthly loan payments. This can be particularly reassuring during economic downturns or periods of personal financial strain.
However, this approach might limit your ability to expand your investment portfolio quickly since your capital is tied up in a single asset.
Choosing to borrow money to fund larger investments can amplify your potential returns. Using the same example, if you decide to take out a mortgage to purchase a $500,000 property, you're essentially betting on the property's rental income and appreciation value outpacing the cost of your debt.
This method, known as leveraging, can be a powerful tool for wealth creation. It allows investors to control a larger asset base and benefit from the appreciation of these assets over time. However, this strategy increases your exposure to financial risk. If the market takes a downturn or if you face challenges with the property, such as vacancies or major repairs, the financial strain of mortgage payments can become overwhelming.
Deciding whether to take on a mortgage for an investment can be clearer once you grasp how money can grow in two main ways: through cash flow and appreciation. When you own a property, you earn money passively through rent, which is a steady stream of income, or cash flow. It’s like having a job that pays you regularly without needing to sell anything you own. On the flip side, there's appreciation, which is when the value of your property increases over time. This isn’t money you see in your bank account month by month, but it represents a potential gain if you decide to sell the property later. Understanding these concepts can help make the decision of whether to borrow money more approachable, guiding you to choose a path that fits your financial aspirations and risk comfort.
Investments come with the risk of loss. However, having a financial cushion provides a safety net that allows you to take calculated risks. Importantly, not all debt is detrimental to wealth building. The secret lies in creating investments that appreciate faster than the rate at which your debt grows, so you can start building towards a more financially secure future.
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