Updated on: April 22, 2021 ; Behaviour
Background:
Wealth creation would be and should be a goal for all of us. Who would not like to enjoy the benefits of a large retirement corpus? Therefore, it becomes very important to take measure to beef up this corpus. But in this race of accumulating wealth, we direct most of our attention, if not all towards increasing our earnings. This results in missing out on a big hidden opportunity. It is time that we shift some focus from earnings, and start paying attention towards managing our investments and savings.
More often than not most of our effort, time and mindshare is spent on activities related to earnings. Our entire daily time table, vacation planning, household planning is dictated by our earnings. It may sound a bit discouraging, but we are sort of slaves of our earnings.
There is nothing wrong with it. It is, of course, the most important element of our lives after our family and our health.
But, is this excessive attention depriving other critical elements of the attention they need? Is there a need to shift the focus from earnings a little bit and focus somewhere else?
Where to shift focus from earnings to?
While earnings are the primary source of any financial corpus, the other elements like expenditure, savings, and right investment strategy are equally important aspects. They supplement the growth of your financial assets.
I have already talked about the importance of managing your expenses and savings here. I have also briefly touched upon the investment basics here.
So I am not going to revisit them in this article. I would be talking about the areas towards which you should shift your focus from earnings.
They are a few very simple constructs that you need to follow. Ideally, there should have been no need to write this lengthy article in the first place. But we as humans tend to ignore simple things and take them for granted.
You will feel the effect of not taking appropriate yet simple actions on time, very late. Unfortunately, it might be a little too late to act by the time you realize this.
So what are these simple actions or concepts?
To put it in a single statement – “Regular investments in your curated investment portfolio for long term with discipline”.
This statement sounds very obvious and facile. Isn’t it? But, how many of us religiously follow it? Actually, this single statement includes a few key principles. I will break down the statement into these core components below.
First, I mentioned the term “regular”. This means that you need to have a solid plan. Your investments can’t be erratic. Having a SIP can be the simplest solution.
Second, I used the term “curated portfolio“. This means that you have to do a thorough study and identify the financial assets for investments. This involves asset selection, asset allocation, portfolio monitoring, and asset restructuring whenever required.
Next comes the term “long term“. To reap the benefits of any investment strategy and the miracle of compounding, you will have to stay invested for a very long time.
Lastly, I mentioned “discipline“. A long term investor will face all sort of headwinds and tailwinds. The idea is to stay focused and continue with your investment strategy without deviating too much. This requires a tremendous amount of discipline and patience.
During times of doom, you should not sell in panic and refrain from speculative investments during times of boom.
Who does it apply to?
You might think that this might not apply to super-wealthy people. They already have millions and billions of money, so why would they care?
You can think of legendary investors like Waren Buffett, who made their fortunes by following these fundamental principles. To that point, one might argue that it is a special case that cannot be generalized.
The truth is that wealthy might not need to manage their wealth as much as the common man because they have enough to perhaps last for generations. But the fact also remains that wealth, if not managed well can be lost quickly.
Even the wealthy need to have a wealth management strategy in place, as there are no guarantees. It could be as simple as locking up all the money and treasures in a secret dungeon somewhere. Although I would strictly discourage such practice, at least it will save them from making unnecessary expenditures.
Jokes apart, the strategy of wealth management could be more on the wealth preservation side than wealth creation for some. It is in their interest to manage it either themselves or through external agencies.
Show me the proof
“If I am earning well and concentrating all my efforts on earnings can further enhance my income, then why should I shift my focus from earnings”? I would be surprised if some of you are not thinking this way.
I will give you the logical answer to this question first, followed by some examples to support it.
Your primary focus should be on increasing or maintaining your earnings. There is no doubt about that. But it should not come at the expense of other things that have the potential to grow your wealth manifolds. And if done really well, under certain circumstances, it can lighten the pressure and the burden of improving earnings off your shoulders.
What I am implying is that, if you try to shift focus from earnings to wealth management a little bit, it could result in a much higher increase in your investment value.
Let’s look at some examples and put this concept into practice.
We will be analyzing two hypothetical scenarios to demonstrate the benefits of the partial shifting of focus from earnings.
We will take the help of our hard-working friend Mr Hardy in our examples. In the first scenario, we assume that Mr Hardy starts with annual earnings of 20,00,000 rupees. He devotes all this time and effort in improving his earnings.
Mr Hardy has a very secure job and consistently gets a 9% increment every year for the next 20 years. In addition to that, he also gets a raise of 25% every 5 years. So, on the 5th, 10th, 15th, and 20th year he gets 9% + 25% of increment on his earnings.
He has a very busy schedule and doesn’t give much thought to his savings or wealth management. As a result, all his savings which account for 30% of his earnings, remain untouched in his Savings bank account. This earns him a return of 3.5% only. Going forward we will address him as earnings-focused Hardy.
In the second variation of the first scenario, Mr Hardy manages to shift some focus from earnings towards wealth management. Please note, it is not that Mr Hardy is spending lots of time doing wealth management. He just needs to put in a few minutes to a few hours every week. As a result, he can deploy his investments at the right place, which earns him a return of 10% per annum. We will call him the wealth-focused Hardy.
Ideally, diverting some focus from earnings to wealth management should not have any impact on Mr Hardy’s earnings growth. But taking a worse-case scenario, we assume that the yearly earnings growth figure drops to 7% from 9%. This gives earnings-focused Hardy a big advantage over the wealth-focused Hardy.
When it comes to savings, we have assumed that the savings are 30% of their respective earnings. This implies that the expenditure is 70% of their respective earnings. As the earnings growth for wealth-focused Hardy is lower, his expenditure would also be less than that of earnings-focused Hardy over the years.
But both the Hardys earn well, and this reduction in expenditure is not going to put a big dent in wealth-focused Hardy’s lifestyle. Moreover, we have artificially deflated the earnings of wealth-focused hardy already. So this difference in expenditure is already over-compensated for.
Time to look at the numbers now. I have computed the annual savings and the investment values, at the end of each year. The same is tabulated below:
The second and the third columns represent the case for earnings-focused Hardy. Whereas the third and the fourth columns represent the case for wealth-focused Hardy.
The last column, named “Gain Factor”, compares the gain of wealth-focused Hardy’s investment value over that of earnings-focused Hardy’s investment value.
At the end of 20 years, wealth-focused Hardy’s investment value was 37% more than that of earnings-focused Hardy’s.
Let’s put things in a better perspective. In absolute terms, wealth-focused Hardy’s investment value was 2,48,79,928 higher. On the other hand, earnings-focused Hardy’s annual income at that time would have been 2,51,05,768 rupees.
So, do you see now? Even with a small shift of focus from earnings to wealth management, wealth-focused Hardy had a bigger investment corpus. And this additional corpus was equivalent to almost a year’s income of earnings-based Hardy.
So, this shows that by a slight shift of focus from earnings to wealth creation, you can be wealthier. Even if your earnings are lower.
This scenario was an ideal scenario where earnings-focused Hardy was earning a 9% hike consistently along with a 5-yearly 25% additional raise. This is a little unlikely to happen in a real-life scenario.
So, let’s look at the second scenario, which is a little less favourable to earnings-focused Hardy. In this scenario, he doesn’t get his 5-yearly 25% raise. He continues to get his 9% annual hike. The same applies to wealth-focused Hardy too.
Other conditions remain unchanged. The results of this new scenario are listed below:
In this scenario, our wealth-focused Hardy earns 54% more than his earnings-focused alter ego.
Now, how does this compare to the 20-year end annual income of earnings-focused Hardy?
His 20-year end income comes out to be 1,02,83,223 rupees. The difference between the two investment values is 2,20,59,573. This is 2.15 times earnings-focused Hardy’s annual income. Even better than the last scenario.
In the real world, the numbers will vary but our wealth-focused Hardy will always be in an advantageous position than our earnings-based Hardy. He will have the better option of what we call financial freedom.
Conclusion:
So a little bit of focus on wealth management can reap greater benefits. In some cases, the benefits could be far greater than the benefits of an increase in your earnings. The difference can be large enough to cover for a few years of your annual income. Even a simple conservative or passive investment strategy should be good enough for those who can’t actively manage his/her portfolio.
So don’t neglect the power of your investment to grow, or even outgrown your earnings.
Set the right focus !!!