In economics, wealth is defined as the net worth of an individual, that is, the value of assets owned by the individual net of all liabilities owed at a given point of time. For a layman, wealth could simply mean being rich. Well, wealth is much beyond these two definitions.

Deloitte, the audit, tax, consulting, enterprise risk and financial advisory services provider defines wealth as follows:

Wealth is the ownership of valuable resources. Wealth creation involves the building of assets by means of careful investment, usually over a long period so as to achieve an income stream that will ensure a continuation of a high-quality lifestyle in the years beyond retirement.

In a nutshell, wealth creation should give you the financial freedom to do what you want to do. For the purpose of long term wealth creation you need to carefully invest your savings over a long period of time so as to ensure that you have a sufficient corpus to meet your financial goals at different milestones of your life child education and marriage, home, and retirement. Hence, a disciplined and systematic investment approach is necessary for wealth creation.

Now, the question is where to invest for wealth creation. The answer to this question really depends on various factors such as your financial goals, age, number of dependents and risk appetite.

There is no one approach for creating wealth but it depends on every individual circumstances and personal choices. Various factors such as financial goals, market risk, return on investments, market volatility should be considered while investing. Your investment is likely to fall in four major asset categories over your lifetime.

debt equity

Equity

Equity includes any money invested in direct equity, mutual funds, exchange traded funds (ETF) and unit linked plans. The value of equity investment fluctuates as per the performance of funds. They can give high returns in the long run, however, they are highly volatile too, especially in the short term. Moreover, you need to be an experienced investor to ensure you are picking up right equity funds.

Debt

Also known as fixed income funds, they mainly comprise of Fixed Deposits (FDs), Public Provident Fund (PPF), National Saving Certificate (NSC) and government bonds to name a few. They give a fixed interest every year, along with the return of the principal amount at the time of maturity. Safety of principal amount and the regular income are the two important features of investment in debt. While the returns are fixed and guaranteed, but they are not high enough to give you edge after discounting for inflation and taxation.

Real Estate

Investment in real estate includes every property that you buy residential, commercial or land as well as the real estate mutual funds. The gradual increase in prices gives more stability to investment. Moreover, regular income can be earned if the property is rented out and the returns on investment can be increased by renovations and repairs. While the real estate market is less volatile compared to the equity market, there might be phases when real estate prices experience volatility. Also, you need to make large capital investments in real estate and it is difficult to sell property quickly. The sale of property is subject to capital gain tax, TDS and some other taxes (depending if the property being sold is constructed or under construction), which eventually lower the net returns from real estate investment. This makes real estate investment rank lower on liquidity and returns on investment parameter.

Commodities

Commodities include precious metals such as silver and gold in the form of coins, bars, ETF and mutual funds. Commodity investment is perhaps the easiest form of investment and can be bought or sold at any point of time as per your financial requirements. Over the long-term, investment in gold and silver can give high dividends and they can be easily mortgaged for availing loans. However, there are no tax advantages and fixed or regular income. Further, people have a tendency to stock up gold and silver rather than selling it. So, that makes commodities a less liquid investment.

Every asset category has its own risk and return profile, so does an investor. There are several investment plans to consider if you plan to invest in equity and debt instruments.

Mutual Funds

A mutual fund is an investment option in which money obtained from various individuals is invested in the securities like stocks, shares, bonds or commodities. Mutual fund schemes charge a small percentage of your investment as fees each year for professional and expert management of your investment. So your risk of losing money through investments is reduced in compared to if you decide to invest directly in the market without having the requisite expertise. There are different kinds of mutual funds such as equity, debt and balanced funds. So, you can accelerate your wealth management goal by investing in different mutual fund schemes depending on the risk you can bear.

However, returns on a mutual fund are by no means guaranteed as they are subject to the performance of funds. If you want to switch from one fund to another, there is no such option available. The only way to protect your investment is to completely exit by paying an exit load and then pay an entry load again if you wish to re-invest. So, if your investment amount in mutual funds is huge, the net returns will get affected.

Public Provident Fund (PPF)

One of the safest debt instruments, PPF investment currently gives an annual interest of 8.75% on deposit amount between Rs500 to Rs1,50,000 every year. The interest and returns on maturity amount is not taxable. However, the downside is that there is a lock in period of 15 years. The only option is partial withdrawal after after completion of 5 years from the date of opening this account.

Fixed Deposits (FDs)

FDs are a safe investment for a conservative investor since it provides a fixed rate of interest and can be easily converted to cash in case of emergency. But, the actual benefits or income from fixed deposit are annulled by the increasing inflation and tax cut. Let’s take an example here. You invested Rs 1,00,000 in tax saving fixed deposits five years back.

Principal Amount Invested (A) 1,00,0000
Interest Rate (B) 10% per annum
Current Inflation Rate (C) 5%
Net Interest Yield (B – C) 4%

Though you will get returns @ 10%, effectively you will get only 4% after factoring in inflation. The final effective return would be even lesser after deducting tax.

Term Insurance Plans

A term Insurance plan is the purest and simplest insurance plan that provides a huge life insurance cover at a very low cost for the specified period of time. If the policyholder dies during the policy term, the death benefit (sum assured or life cover amount) is paid to the nominee. The premium as well as death benefit are tax-free. There is no maturity benefit, though. An investment in a term insurance plan is highly recommended for your peace of mind and to ensure financial security of your dependents after you are not around.

Unit Linked Insurance Plans (ULIPs)

ULIPs are a goal-based investment that provides the benefit of insurance protection with strong wealth creation opportunities. A part of money invested in ULIPs is directed towards your life cover and the residual portion is invested in equity, debt or balanced funds of your choice. Though the returns on your investment is market-linked, you have a control over it since you have the flexibility to switch funds from equity to debt or vice versa at no cost, as per your financial goals and market fluctuations.

ULIPs have given steady returns over the last few years. ULIPs with an aggressive fund allocation (50-75% of the portfolio in stocks) have risen to 28.62% from 9.73% in the last five years.

Ulips

Source

ULIPs have a greater tax advantage too. Under Section 80C of the Income Tax of India a deduction (maximum of Rs 1,50,000) from the taxable income of individual is provided for the premium paid on ULIPs. The capital gains, maturity benefit and death benefits are also exempted from tax under Section 10(10D). ULIPs from reputed private insurers like ICICI Prudential have proven performance and track record, thereby commanding a trust and respect of investors.

Ideally, your wealth portfolio should be a healthy mix of equity, debt, real estate and commodities. But, again how and where you invest depends on your wealth creation goals and risk-return trade-off you are willing to take off. What you must remember is that wealth creation is not an overnight phenomenon. You must be disciplined, systematic and committed in your wealth creation approach.

This entry was posted on Tuesday, November 24th, 2015 at 4:10 pm and is filed under Personal Finance, Wealth. You can follow any responses to this entry through the RSS 2.0 feed. Both comments and pings are currently closed.

Comments Off on How Does Wealth Creation Work and What Kinds of Plans are Available?

Comments are closed.