For most investors, the ultimate goal is to accumulate enough wealth to generate passive income that covers living expenses. This provides the freedom to choose how to spend one’s time without the need to work for income.
However, many investors make the mistake of focusing on income when they start their investment journey. This approach is slow and inefficient, similar to teeing off with a putter in golf. It may eventually get you to the green, but it will take too many shots.
A more efficient way to build wealth is to follow a two-step process. First, focus on building your asset base. Once you have a strong asset base, you can then tilt your asset allocation towards income.
Investing for income initially can result in a significant loss of return due to taxes. When an investment generates income, a portion of that income is typically lost to taxes. On the other hand, investments focused on capital growth allow for reinvestment of the full return until the investment is sold.
Comparing shares and property as investment options can be challenging for many people. However, assuming the right strategy is adopted, both shares and property can provide comparable overall returns. The key difference lies in the amount of income generated. Property tends to provide around 30% of its overall return in income, while shares offer a more balanced 50/50 split between income and capital growth.
Diversification across various asset classes is crucial to mitigate risk and maximize long-term returns. Shares play an important role in investment strategies, particularly within superannuation to minimize tax on income returns. However, it is generally recommended to invest in shares after acquiring a sufficient amount of property investments for tax and wealth efficiency.
If you need to build your asset base, it is advisable to invest in assets that primarily generate capital growth. These assets should be of high quality and borrowing to purchase them can be an effective strategy to accelerate wealth accumulation. However, it is essential to seek personalized advice before making any investment decisions.
Editor’s note: This blog was originally published in July 2018 and has been republished for the benefit of our many new subscribers as the information is just as relevant today as it was then.
