It’s important to build on sound foundations when investing.
Generally speaking, it’s true to say that saving and investing are closely related. You can only create long-term wealth by investing. But savers should first create a sound base before taking on investment risk. This way, a good financial plan provides security and contributes to long-term wealth creation. Long-term wealth planning is far more complex than focussing on a specific amount. When setting up a long-term financial plan, how you wish to use your assets is crucial in determining how you should manage them.
Prepare for the unexpected
When setting up a financial plan, the key is to prepare for the worst and hope for the best. Act with foresight to anticipate potential personal crises such as a job loss or illness. We recommend a pyramid system with several levels and sound foundations, which also offers the flexibility required to generate capital growth, once the foundations have been laid.
The base of the pyramid should be a rainy day fund, a reserve to cope with any unforeseen expenditure such as a leaky roof or unexpected bill, and money for major outgoings such as the purchase of a car or a down payment on a house. This amount should be held in liquid funds that you can readily access. This is the indispensable basis for any savings plan, and any subsequent steps which will contribute to successfully managing your own finances.
A key element in this first level of the pyramid is the savings account. Interest rates are universally low, but there are still differences. Once you’ve found the right account, you should pay in small amounts regularly, for example via standing order. It may make sense to make these payments each month as your salary arrives on your account, that way you won’t spend it on other things.
How you wish to use your assets is crucial in determining how you should manage them.
Protection is crucial
Once you have established your capital, you can tackle your long-term savings options, i.e. the next level in the pyramid. This includes protecting your family against a sudden loss of income due to illness or unemployment. In concrete terms, this means taking out life insurance and/or a retirement savings plan. A key component in this is generally your occupational pension scheme. The social security system in Luxembourg provides for two elements to the old age pension, a flat amount for those who have made contributions for a sufficient number of years, and an amount that is dependent on earnings. These are financed by contributions by the employer, employee and government, and are coupled with tax breaks. Employee pension contributions represent 24% of salary. Personal retirement savings plans and insurance products are an option for anyone wishing to save more. As a reminder, the self-employed also pay into the retirement scheme, but at lower contribution rates.
Insurance is an important element in financial planning. Employers often pay death benefits for employees, and also provide a certain level of health insurance. However, it’s important to check carefully if adequate cover is provided for the whole family. Any shortfalls can be covered by life insurance. Income or disability insurance are further options for providing cover against job loss or an inability to work due to illness.
The time factor – the issue of risk
Now for the top of the pyramid, investments. First off, timing is a key factor here. You generally get a better return if you are prepared to tie up your capital for longer. For example, you will get a higher interest rate for your savings on fixed-term deposit. Depending on how much risk you wish to take, riskier investments such as equities may also form part of a long-term approach which can ride out short-term fluctuations.
The fact is, stock market prices can fluctuate significantly in the short term. This was evident in 2020 when markets collapsed in the wake of fears surrounding the COVID-19 pandemic. Markets subsequently recovered, but investors who sold in February or March 2020 are likely to have suffered losses. So a stock market investment is not generally a good option if you will need the money in the short term.
The right investment strategy depends on your risk tolerance, knowledge and experience of financial products, time horizon and the amount of money you are willing to put on one side. The best option is probably a mix of investment products such as investment funds, structured products, equities and bonds.
You can invest in assets offering higher potential returns if you’re prepared to accept some degree of volatility in asset values. You must decide for yourself what level of risk you are prepared to accept. Your banking adviser can offer valuable support and advice whether you’re talking about comprehensive asset management, products restricted to order execution, or somewhere between the two.
It is not a good idea to permanently hold high levels of liquid assets if your aim is long-term wealth creation.
One last tip: it is not a good idea to permanently hold high levels of liquid assets if your aim is long-term wealth creation. Given low or even negative interest rates on many savings accounts and the expected rise in inflation, the purchasing power of savings will fall over the long term. You should therefore only hold as much money as you will need in the short term, or for an emergency.