How is wealth created?

As a Certified Financial Planner, I’m often asked by women how investments work, and why they should invest outside of a savings account.  Without a clear understanding of why you should invest in a company in business in an attempt to make a profit rather than putting money in a savings vehicle like a CD, it may be easier to take the path of least resistance.  Let me explain.  The bank or credit union pays you one quarter of a percent (or less) on your deposit, which is in essence a loan to the bank, and they loan money out to others at 4% to 5%. You may get a bit more on a CD, but that, my friend is capitalism.  A savings deposit pays one quarter of a percent (.25%) to the loaner (you); and 4.75% to the owner (the bank). In order to accumulate meaningful savings, it is often necessary to take on some investment risk. So that leads to the question:

How is wealth created? 

There are four things required in order for wealth to be created.

1.         Financial capital or money.  Money is necessary to be invested in order for a company to manufacture a product or provide a service for a profit.

2.         Natural resources.  Oil, gas, land and gold and other commodities are assets that can be used in creating products.

3.         Intellectual capital.  A great idea or a new way of delivering a product or service is an example of intellectual capital.  Think Apple i-Phone or the Google search engine.

4.         Skilled labor.

When all four of these things come together, wealth is created.  If we provide capital to a company through investment of our money, that entitles us to a piece of the wealth created.  Investing, in its simplest form, is saving a part of what you earn, having an investment philosophy or discipline and a roadmap, and paying attention to the cost of the investment.  If you’re not sure how to proceed, engage a Certified Financial Planner and they will help you make a plan.  Don’t wait for your husband or your father or some other man in your life to do this for you.  You are capable and qualified to do this on your own.

The best advice needs no more than a 4 by 6 index card (Continued).

The best advice needs no more than a 4 by 6 index card (Continued).

 

If you missed my last blog, please go back and read it first, as this is a continuation of the advice given by University of Chicago Professor Harold Pollack and my commentary on how to put the advice to use (my advice is in parenthesis unless otherwise noted).

6. Maximize tax advantaged savings like Roth, SEP and 529 accounts. (If this sounds like financial mumbo jumbo, don’t despair.  A good basic investment class, book or advisor can explain how all these work in layman’s terms and help you understand how they can help you meeting your long term goals).

7. Pay attention to fees, avoid actively managed funds. (Fees matter in mutual funds and it is important to know how to evaluate these fees. Actively managed funds can beat an index fund but it is highly unpredictable and only realized in hindsight. Less than .001% of 5-star top performing actively managed funds are still at the top 5 years later.

8. Make financial advisor commit to a fiduciary standard (i.e. Puts your interests as a client ahead of their own, disclosing any conflicts of interest and providing independent advice).

9. Promote social insurance programs to help people when things go wrong. (Many people can afford to plan for the things that can go wrong by purchasing life insurance to pay debt and provide income for family. They can buy long term care insurance to protect their assets for spouse and possibly children as well as save part of their money for the future so social security isn’t the only source of income. Participate in retirement plans. The list goes on and on. If you think partnering with an advisor will help keep you on track, go for it. The fee you pay to do the right things for your family could prove to be “priceless”.)