Wealth Management: Putting into Perspective !!
One day, late evening I got a call from my brother, who recently graduated as an Engineer and started his job. He asked me about one mutual fund scheme which apparently looked lucrative to him. He asked, “Do you know about this scheme? Its returns are so much better. I want to start my savings. Can I start putting my money in this scheme?” Also, he just turned 23. So I kept listening to him and how keenly he was telling me about the scheme and also appreciate his thought to start his financial planning from the very beginning of his career. At the same time, it is also important to note that such random encounter with any financial product and attraction towards the same based on prima facie information may become financially fatal. Thus it is of utmost significance that such nascent, enthusiastic & curious thought process should be driven with proper guidance and planning so that one can inculcate a good financial discipline during the journey of life.
Owing to this, I thought of writing this blog for those who are novice to finance and wealth management. I truly believe that wealth management is not merely an activity but a process which actually begins from the birth of a child to the demise of the oldest in a family.
Managing wealth is and has been a vital part in our life, be it personal finance or business finance. It is important to have right perspective while you engage yourself in decision making process of wealth management as you have built your wealth with the hard earned money; which is the result of years of effort, some hardship and some sacrifice.
So what do we mean by Wealth Management? – Firstly, wealth means the money and the assets that you own. Secondly, when you intend to manage this wealth with the objectives of capital protection, value protection and value creation, it is collectively known as wealth management.
Based on these objectives, simply, there are three important aspects of wealth management – Wealth Preservation, Wealth Conservation & Wealth Creation. You need to understand each of these aspects in order to form a clear perspective for effective planning.
First is Wealth Preservation – To preserve means to keep something intact or as it is. Let’s understand with an example – Suppose, Rs. 100 Crores is your total wealth. You want to keep this wealth protected and do not expect to earn anything on such wealth. Basic agenda here is to protect what you have. Preserving wealth would primarily mean protection of your capital.
Second is Wealth Conservation – To conserve means to prevent something from loss or damage. One of the biggest risk/loss in case of wealth is losing its value. It has been rightly said that “Time is money”. What you really need to focus here is “Time Value of Money”. If you don’t consider this fact, you may end up losing the worth of your wealth over a period. Thus aim is to protect the value of money.
So what you need to do?
In the above example, you had total wealth of Rs. 100 Crores which you just wanted to protect and didn’t wish to earn or create any value over it. Now let say we divide your total wealth into two equal parts – One part needs to be protected while on the other part you wish to earn as much so as to protect its value.
But Wait! How can one protect the value of money? How to assure that the value created is adequate or not?
The answer is Inflation.
Yes, one needs to consider the rate at which price rise occurs and such rate is known as Inflation rate. If you look at the data for last 5 & 10 calendar years, average annual inflation rate (Consumer Price Index till 31.12.2018 – Source: macrotrends.net) in India comes to 4.90% and 7.65% respectively. If we conservatively assume the expected annual inflation rate to be 7%, your wealth needs to grow at 7% so as to conserve its worth. In simple terms, if your purchasing power is Rs. 100 today, you need to earn/add Rs. 7 more by the end of the year (or every year) to maintain the same purchasing power.
Hence in this example, Rs. 50 Crores of wealth needs to be protected while another Rs. 50 Crores needs to grow at 7% to prevent from losing its value.
The third and a crucial aspect of wealth management is Wealth Creation.
Wealth creation would involve investments. Creating wealth has two elements: one is accumulating wealth over a long period of time and the other is value creation & income generation from such wealth. To create value, your money needs to grow at a premium over risk free rate/inflation rate. Considering the above example where expected annual inflation rate was taken as 7% and if we assume to earn a premium of 3% additionally then expected rate of return is 10%.
Now for generating this premium, there are several wealth creating assets and investment vehicles such as business investments, real estate, gold, equity, bonds, mutual funds, alternative investment funds etc. You need to understand which of these suits your purpose, behavior and risk appetite since each of these assets/investment vehicles have its own characteristics and risk.
Talking about “Risk” – it is implied that money making is not easy and as they say “Easy money will not stay”. And thus whatever you earn over risk free rate/inflation rate is called Risk Premium.
In nutshell, choice of asset class, time frame for investment, return on investments, risk involved are some of the key factors which you need to consider while making a decision.
To understand it better let’s take an example based on some historical data. Suppose you invested your money in an equity index fund or a debt fund or a gold fund or all three. Below are the figures of return on investments (in %) for each calendar year from 2007 to 2018:
Year | 2007 | 2008 | 2009 | 2010 | 2011 | 2012 | 2013 | 2014 | 2015 | 2016 | 2017 | 2018 |
E | 53.23 | (51.96) | 73.80 | 17.73 | (24.83) | 28.14 | 6.86 | 31.77 | (3.35) | 4.00 | 29.68 | 4.23 |
D | 6.22 | 9.85 | 5.95 | 5.42 | 8.32 | 8.95 | 9.75 | 8.84 | 8.51 | 8.87 | 6.65 | 6.98 |
G | - | 25.65 | 22.36 | 21.72 | 30.92 | 10.88 | (14.12) | 0.93 | (8.21) | 10.78 | 3.14 | 7.17 |
Here E=Equity Fund, D=Debt Fund, G=Gold Fund. Also the average annualized returns of these funds are approximately 10%, 8% and 7% respectively if you keep your money invested since 2007.
As you can see in the above table, different asset class have different return, risk and volatility which may or may not suit to behavior of every investor. Some of the asset class will have linear returns while some involves volatility in short term but will perform better in longer term. Hence one needs to be prudent about wealth creation strategy.
Considering all the three aspects of wealth management, one can set right perspective, right approach and right set of processes to plan for their money. Thus if one needs to be advised, who would be starting or who had just started his/her financial journey, just like my brother as above, he/she should approach the financial planning with proper understanding of each of the elements of wealth management as it has been very well said by Robert Kiyosaki,
“It’s not how much money you make
But how much money you keep, how hard it works for you,
And how many generations you keep it for”
Thank you for reading!
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