Potential riches often lead us to risky decisions

Sometimes the most important role of the financial planner is to protect clients from themselves. The temptation of potential riches often leads us to making risky decisions.

I once heard someone say, the best way to get rich is to earn more than you spend for a long time. Although not exciting, it is true.

Managing risk is crucial to successful wealth creation.  Resisting the temptation for the quick win is part of this risk management.

Most of us have heard of “a friend of a friend” picking a mining stock (or in the early 2000’s a Tech stock) for a few cents, that goes through the roof and is now worth a 100 times what they paid for it. These speculative stocks do hit pay dirt on occasion.

The truth is, for every mining company that finds a rich vein of uranium (or alike), there are many more that find nothing, and therefore the stocks are worth literally nothing. Buying a speculative mining stock is literally gambling, and should be treated as such when developing a plan.

A more robust share strategy is to invest in a diverse range of proven companies in a variety of industries. This sort of portfolio is not going to make you rich overnight, but also has significant less risk than purchasing a speculative stock.

Another get rich story we have all heard is the couple who bought 15 houses in 5 years using the equity in the previous houses. Building a property portfolio is an excellent way to build wealth but, it needs to be built over time in a controlled manner.

The quick accumulation of property with little equity in each property and high levels of debts leads to a huge risk exposure. With high levels of debt, interest rate risk exposure is enormous. If you are carrying $3 Mil of investment debt and interest rates increase by 2%, you will need to find an extra $60K a year in interest repayments. If you have 10-15 properties, before long you will have a lot of maintenance costs.  If you are relying on the income from the rent to meet interest costs, cash flow for maintenance is a big problem.  Same goes if a property or 2 goes untenanted for any length of time.

Building a property portfolio is an excellent method to build wealth, if done properly. It is sensible to have high levels of equity and carry levels of debt that would be see the property remain cash flow positive with higher interest rates. In addition, have cash buffers that allow for maintenance and periods where the property does not provide income. It will be a slower build, but more sustainable.

The secret to getting rich, is no secret at all, it is simply a matter of good decisions over a long period of time.