Newsletter Archive

“When money realizes that it is in good hands, it wants to stay and multiply in those hands.” (Idowu Koyenikan)

This month we take a look at six of the most significant barriers to wealth creation and financial independence. No matter where you are in your life journey you will be able to learn something from this article. Read on to ensure you don’t make the same mistakes that others have made.

1. Too little too late

   The most significant barrier to wealth creation is being late out of the blocks. You should start investing as soon as you start earning. As a minimum, you should be putting 15% of your income towards a diversified portfolio which includes enough equity for long term capital growth. Ideally, it should be more. In South Africa, you can contribute up to 27.5% of your income to retirement funds and use the amount as a tax deduction. This effectively reduces your marginal tax rate and frees up income to invest elsewhere. This sets a very good standard: if you consistently contribute 27.5% to a retirement fund, you’re very likely to be entirely financially independent in your golden years.

2. Dipping into your pension

   In today’s world, people usually don’t stay with one employer throughout their career. When they change jobs, there’s the great temptation to withdraw from their pension funds instead of transferring the whole amount to a preservation fund or retirement annuity. There may be a very good reason to withdraw some of the funds (such as paying off expensive debt), but in most cases, it’s best to transfer the whole amount. Any other course of action will undo all the good achieved by your previous investing.

3. Living it up with debt

   Using debt to sustain an unnecessarily lavish lifestyle is another huge barrier to long-term wealth creation. In most first-world countries minimalism is now in vogue, and people are moving fast towards cost-cutting measures like house swaps for holidays and using public transport to get to work (admittedly this can be tricky in SA). Most wealthy and successful investors live well below their means (in the process of creating wealth) and never use credit to pay off assets that depreciate in value, such as cars.

   Folks are all too aware of the benefits of compound growth but unaware of how hard it works against them if they don’t pay off their credit cards every month. The monthly interest amount (cost of debt) is added to the principal amount each month, and you keep paying interest on an ever-growing heap of debt.

4. Trying to time the market

   John Bogle, the founder of the US investment company Vanguard, calculated that the average equity unit trust investment gained 173% between 1997 and 2011. In the same period, the average investor in equity funds only gained 110%! This is primarily because investors end up selling low and buying high instead of the other way around.

   When the markets are gaining value investors can be influenced, by the overconfidence, recency, and herding biases. This means they keep buying more stock thinking that the upward trend will continue – thus buying high. And then, when the markets take a turn (part of the natural investment cycle), investors panic in fear of further loss and get out of the market – thus selling low. Instead of trying to time the market, play a long game and try not to be swayed by short-term peaks or troughs.

5. Not managing risk well

   Another barrier to wealth creation is not managing risk correctly. In life, no-one is granted a totally smooth ride. If you have a young family who is financially dependent on you, it’s critical to have life cover with extended benefits. More so if you have debt. If you become critically ill and you don’t have income protection, you could lose your home or be forced to send your children to a less expensive school. It’s equally essential to have health cover even when you’re young and feel invincible. Accidents do happen and time in ICU can seriously jeopardize your family’s financial security.

6. Extravagant homes

Living in an overly extravagant home is a significant barrier to wealth creation. It would be best to regard your home as a lifestyle asset, not an investment. In South Africa, the real rate of return on residential property has been declining over the years. And you need to maintain it. It’s recommended that you spend at least 1% of the value of your home on maintenance every year.

Many people throughout the world are consciously downscaling their homes. This frees up income which allows them memorable experiences such as travel and the ability to educate their children offshore.

The bottom line

Learn from other people’s mistakes! Financial advisors see these kinds of mistakes all the time, so listen to your advisor when he or she sounds a warning. Also, remember to take nothing for granted and to embrace lifelong learning.

To discuss more on wealth creation, speak to a professional.