Investing Is Prudent Financial Planning

A great deal of financial planning advice includes a stern admonition to always save ten per cent of one’s income. Saving is an excellent habit to nurture, and can help with short term goals like vacations or the annual back to school supply run.

However, for longer term financial planning — like planning for retirement, funding tertiary education or just becoming financially free — saving money isn’t enough. Investing is a much more reliable way to build wealth.

Investing is a process by which a sum of money or an asset earns money for the owners of that sum or asset, usually without any direct financial contribution from the owners themselves.

Why is investing preferable to savings on the journey to financial freedom? One idea is that people who are employees (as opposed to those who are entrepreneurs) can never put aside enough cash from their salaries to purchase valuable income earning assets and build wealth, which is partially true.

Consistently saving money on a fixed income is a tough task, particularly when unforeseen events help to drain what savings you do manage to put aside. Medical emergencies, for instance, can cost thousands of dollars for prescriptions, specialist visits, surgeries or hospital stays. And during the current Covid-19 pandemic, many families have seen their savings reset to $0 because of income loss.

Another reason that investing is more effective than savings when growing wealth is because of inflation. Simply put, $1 in 2020 can buy one Power Mint candy, when in 2000, it could have bought four of the same candies. Most currencies lose incremental value over time. So even if you save a sum of money now, that same sum will not have the same purchasing power in 20 years.

Investment tools are categorised according to the amount of risk they entail from the investor. When you invest, you are taking the chance that your investment's actual return will be different than expected. Every investment carries some level of risk and you must establish your own level of risk tolerance. High risk investments give a greater earning potential and tend to mature in a shorter time than low risk investments. But the higher the risk, the greater the chance of losing some (or all) of your initial investment.

A simple investment product like an annuity allows individuals can build retirement savings on a fixed income, and earn interest to add to the eventual purchasing power of their contributions. During the accumulation phase, individuals can make payments at regular intervals or lump sum payments at more infrequent intervals, and their savings earn them interest over time. The money saved is not easily accessible, so impulse spending is eliminated. Many annuities are also tax deductible.

At the end of the accumulation phase, accounts enter the payout phase, where account holders can either withdraw their lump sum savings, with interest, often tax-free. Or, they can choose to receive a series of payments to live on in the retirement years. Annuities are low risk investments, so there is very little chance of losing what money you have put in.

Bonds are another low-risk investment that can earn on an investor’s opening contribution. A bond is a contract in which individual investors, also called bond holders, ‘lend’ money to an entity, usually a government or established corporation. Investors receive an official certificate in exchange for money borrowed, where the entity or bond issuer guarantees that the loan will be repaid with interest within a certain time period. Bond holders must wait for the bonds to mature before they can receive their capital and interest in cash.

Mutual funds are low to medium risk investments that can help individual investors take advantage of high-yield investment opportunities that typically only investors with large capital sums have. The funds may invest in securities or equities, and may participate in investment opportunities outside of the country or region where most of the investors originate.

Mutual funds act like a pool where many investors lump their contribution together to act as one investment, and investors may or may not be able to cash in in the short term. Each investor gains a relatively stable risk of return, according to their contribution, and the fund helps to diversify portfolios.

Diversification manages the risk of high-yield investments by including a wide variety of different types of investments in one opportunity, so that returns do not depend on only one or two opportunities to get returns. A truly diverse investment portfolio contains a mix of low, medium and high risk opportunities.

If you invest in securities as an individual, without the buffer of a mutual fund, this is considered a higher risk investment because of the relative unpredictability of an open securities market. Securities are negotiable financial instruments that represent some type of financial value. Securities are typically divided into debt securities and equities. A debt security is a type of security that represents money that is borrowed and must be repaid under very specific terms, like the contracts that govern government and corporate bonds. Equities typically represent stock/shares in various companies. Buying company shares on a public securities market is one of the most traditional ways to invest.

Investing is not just for those who are already wealthy. Anyone with capital has access to using investing to build wealth and financial freedom...