Creating a significant amount of wealth during your lifetime cannot be done by saving alone and usually requires the use of other people’s money. Borrowing money from others to invest in businesses and property is referred to as a leveraged investment strategy. Leveraged investments are capable of producing significant wealth, providing the funds invested produce a return greater than the cost of borrowing. Most commonly, this strategy is used for investing in property. The problem with leveraged investments is that while they magnify the effect of good investment returns, they also magnify the effects of bad returns. A leveraged investment strategy therefore requires a solid foundation to avoid financial ruin. The basic building blocks are:
- Money management skills. If you can’t manage your own money properly (i.e. you don’t know where it goes and you can’t save) then you aren’t going to be able to manage borrowed funds well either.
- A financial buffer. Borrowing up to the maximum limit with no room to move means you could easily come unstuck if things don’t go to plan. Have unused credit or savings to fall back on.
- Consistent income from more than one source. Diversification is a key word for investment strategies and being reliant on only one primary source of income, such as a single salary, can be disastrous.
- Risk protection. Borrowing money increases your financial risk. Put insurance cover in place to cover adverse events. Make sure you have the right ownership structures so your personal assets are protected if investments fail.
- A store of wealth. Don’t risk everything you have. As you create wealth, set some aside in safe investments so that if your risky strategies fail, you don’t lose everything.
Building on these foundations won’t eliminate risk but will certainly reduce it.