To demonstrate the power of the Investment Fundamentals, I will use Jude as an example. Jude is 20 years old and is on the minimum Federal wage of $28,280 per annum. Jude has no knowledge of investing but is keen to get started as she has heard of the importance of saving and investing.
1. SAVE at least 10% of your income and put these savings to work
In this day and age of immediate gratification and trying to keep up with the Joneses, one of the simplest, yet most ignored rules of investing is to spend less than you earn. Unless a conscious effort is made to put away a portion of your income, your ‘necessary’ expenses will always increase to match your income.
“Control thy expenditures … you do not all earn the same, some earn much more than others, some have much larger families to support. Yet all purses were equally lean. Now I will tell thee an unusual truth about men and sons of men. It is this, that what each of us calls our ‘necessary expenses’ will always grow to equal our incomes unless we protest to the contrary.”
- The Richest Man in Babylon
 The easiest way to do this is to pay yourself first. Before any of your wage or income is spent, allocate at least 10% to some form of savings account, investment account, debt reduction or the payment of investment interest.
The power of saving 10% of your income can be nicely demonstrated by looking at Jude. Jude has gone through her budget and has found that she can actually save 10% of her gross income, on top of the 9% compulsory superannuation contributed by her employer. Jude is pretty conservative, so doesn’t want to gear and invest these savings into superannuation where she anticipates a real return (adjusted for inflation) of 7% per annum.
By following this simple strategy Jude will have accumulated a total of almost $1.15 million by the time she reaches the age of 60. This would provide her with a retirement income of approximately $92,000 per annum (in today's dollars), or alternatively she could purchase a primary residence worth $350,000 and still have a retirement income of $64,000 per annum (in today’s dollars).
… Not bad for someone who spends their life on the minimum wage and follows a very conservative investment strategy.
Once you have mastered the powerful art of saving it is important to let these savings accumulate and grow. As your ‘purse’ grows, avoid the temptation to gratify your short term needs by dipping your hands into your savings …
2. Be patient and take advantage of the wonders of COMPOUND returns.
“Every dollar saved will earn interest and this interest will earn interest, the longer your savings and investments remain in place the more your money will work for you.”
The simple graph below demonstrates the power of compound returns. Let's assume Jude has an initial investment of $5,000. This earns 7% per annum and remains untouched for the next 40 years. This initial $5,000 investment will have accumulated to a total investment of almost $75,000;
As the above graph demonstrates, whilst your total savings accumulate gradually at first, as time goes by your accumulated savings will increase with greater ferocity. Analysing this further, the below table demonstrates how the return of $350 in year 1 has increased to $4898 by year 40.
Year |
Principal |
Return |
Accumulated Interest |
Total |
1 |
$5,000 |
$350 |
$350 |
$5,350 |
10 |
$5,000 |
$643 |
$4836 |
$9,836 |
20 |
$5,000 |
$1,266 |
$14,348 |
$19,348 |
30 |
$5,000 |
$2,490 |
$33,061 |
$38,061 |
40 |
$5,000 |
$4,898 |
$69,872 |
$74,872 |
It also demonstrates the importance of leaving your investments in place for as long as possible. It takes 30 years for Jude’s $5,000 to grow to $38,000, however this increase of $33,000 is then achieved in less than the following 10 years.
3. PLAN: Know where you are, what you want and how you will get there
 Before Jude gets too carried away with accumulating and investing her savings it is very important that she gets a very clear picture of what she wants to achieve. Whilst our above example saw Jude in a relatively comfortable retirement, what if she also wanted an overseas holiday in five years, wanted to fund her kids education in ten years or wanted to buy a home in 15 years?
Unless Jude knows what she wants and targets her savings and investments with those goals in mind, she’ll be sure to end up with assets in the wrong place at the wrong time. For example, if Jude had only focused on her superannuation investments (which she cannot access for another 40 odd years) she might find that at age 35 she has a lovely superannuation balance but no cash available to purchase the home she wanted.
Where are you now?
Questions such as: what do you earn, how much do you spend, what can you save, what assets and liabilities do you have in place, how old are you, when do you want to retire and so on, will have a large bearing on what investment strategies you should follow. We must have a clear picture of what you have to work with before we can start making any assumptions about what sort of investments you should make. The Personal Financial Profile is an ideal place to start recording the answers to these questions.
The answers to those, and other questions will also largely determine whether your goals and objectives are achievable, which brings me to my next point …
What do you want?
To work out what your goals are, it is better to start from the end and work backwards. What do you want out of life? Create a vision for yourself that embodies everything you want to achieve in your life and work backwards from there. Create short, medium and long term goals that are in line with and help you towards your vision.
How will you get there?
Once you have the above information at hand, consult with your Adviser to come up with a strategy to achieve your goals and objectives. Combining the savings and investing strategies outlined below, with a specific plan to meet your goals and objectives will ensure that you are continually moving in the right direction.
Jude is now clear about what she wants from her life, and is excited at the prospect of investing. She now feels empowered that she has complete control over her destiny. Jude could do nothing but follow these first three simple strategies and she would be better off than the majority of the population comfortably meeting her long term goal of a self funded retirement.
To recap, the first three investment fundamentals can be summarised as follows:
1. SAVE at least 10% of your income and put these savings to work
2. Be patient and take advantage of the wonders of COMPOUND returns
3. PLAN: know where you are, what you want and how you will get there
The last two Investment Fundamentals are outlined briefly below and will be covered in greater detail in coming months. The final two Investment Fundamentals (below) will enable Jude to achieve her goals at a faster rate and in a more efficient manner whilst also ensuring that her risks are substantially lower.
4. INVEST your savings WISELY;
a. Look to the Economic Clock; The market moves in cycles, consider which of the major asset classes are more likely to outperform (or under perform) over the short to medium term … “Be greedy when others are fearful and fearful when others are greedy”
b. Consider your options:
i. Asset Classes; shares, property or cash;
ii. Strategies; debt reduction, superannuation, gearing, cash investments
c. Stick with simple, easy to understand investments
d. Build a diversified portfolio
5. LOOK DOWN as well as up; consider the implications of various unfortunate events and guard against these using buffers, insurance and good planning.
If you want to discuss your plans and how your investments are helping you towards your goals, contact your Hudson Institute Financial Advisor. |
