For most people, building wealth is an essential element of their financial wellbeing. The three factors which have the most significant impact on how much wealth you accumulate are:

The amount you save
How long your money is invested
The returns you achieve each year (net of costs and taxes)

As a general rule, the higher the expected or potential return, the higher the level of risk. Risk means the possibility of a total loss of capital, fluctuations in the daily value of your investment or the potential for future returns to be lower (or non-existent) than anticipated (based on historical performance).

But these risks also need to be balanced with the risks of not investing. The two key risks being not having enough money to meet your later lifestyle needs and inflation eroding the buying power of your money over time.

There are three basic ways that you can deploy your money:

Speculating

Speculating is when you take a punt or bet on a low chance of an abnormally high return happening over a relatively short period of time. The price you pay is a high probability of a total or significant loss of your original capital.

Speculating is just like gambling. A few lucky people make big money, and everyone else nurses losses.

Examples of this include peer-to-peer lending, crowdfunding schemes for tiny start-up businesses, property bonds like those promoted by TV personality Kevin McCloud, or fraudulent Ponzi schemes like the one run by the infamous hedge fund manager Bernie Madoff.

Social media is awash with messages about how to make money. Whether it's the allure of high interest from crowdfunding lending, instant riches from cryptocurrencies, or attractive returns from various property related schemes, it's easy to think you're missing out on a good thing. Much of the commentary is about speculating, not investing, and you should avoid it like COVID-19.

Remember that there are no high return, low risk investments. Keeping that front and centre of your thinking will help you avoid being conned, duped or misled into a financial blowup.

“Remember that there are no high return, low risk investments. Keeping that front and centre of your thinking will help you avoid being conned, duped or misled into a financial blowup.” Tweet This

2. Savings

Savings is money placed in a cash-based savings account, which promises to return your original capital, with a certain amount backed by a government protection scheme. Some, like current accounts, pay no interest. While others pay interest currently of up to about 1.25% pa, depending on how much access you need.

Savings accounts are not the right long-term home for the bulk of your long-term capital as they lose money relative to inflation. But they are ideal for cash that you'll need in the shorter term or for spending emergencies. In that respect, the interest is less important than the security of your capital.

3. Investing

Investing in the shares of the leading companies of the world (including those invested in real estate) has proved to be a wise thing to do over the long-term. You could also invest in physical property, which has been a good long-term investment, but as that usually requires most people to borrow, I don’t recommend it as part of my Money Milestones framework.

But the daily value of share-based investments can be very volatile because they reflect daily news, investor sentiment and supply and demand.

In March this year, as the COVID pandemic unfolded, global stockmarkets fell over 30%, before recovering most of those falls over the new few months. But there have been times, like in the 1972-74 period, when global stock and property markets collapsed. For example, the UK stockmarket fell over 70% in less than two years and then took over ten years to recover its real value.

You have to be able to leave invested money alone for many years - ideally decades - to allow returns to accrue, and ride out the falls that always happen. That's easy in theory but harder to do in practice, because us humans make money decisions on an emotional, not a logical level.

Are You Ready To Invest?

To be able to stay the course in the face of gyrating investment markets, you need to be ready to invest.

That means you must have completed 1 to 4 of the Money Milestones, namely:

you have control over daily spending (in the form of a smart spending plan);
you have no non-mortgage debt; and
you have a fully-funded emergency fund.

Until you've achieved those milestones, you have no business investing.

The Exception - Workplace Pensions For Free Money

The only exception is if you are an employee. In that case, you should join (or in the case of UK employees do not opt-out of) your workplace pension plan and make the minimum contribution to get your employer's pension contributions. (For UK employees their employer contributes 3% of salary in return for a personal contribution of at least 5%.)

As long as you have at least 20 years before you'll need to draw upon those funds to meet your later life needs, you can invest those contributions mainly in shares for the maximum long-term return. Daily fluctuations should not concern you while you are accumulating.

Once you've completed Money Milestones 1-4, you should then save and invest 15% of your household income towards retirement. That's Money Milestone 5. The investment tax wrapper you use will depend on where you live. But do as much towards any retirement account to get any 'free' contributions from your employer if they pay more than the legal minimum of 3%.

Investing More Than 15% of Income

Whereas you need to do Money Milestones 1-4 in order, Money Milestones 5-8 can be done at the same time and to the degree that makes sense to you.

Make sure you have sufficient income protection and life insurance to protect you and any financial dependants (Milestone 6). Overpay your home mortgage each month to repay it early for a risk-free return (Milestone 7). And invest higher amounts and give to good causes (Milestone 8).

You can decide how to allocate your income towards overpaying the mortgage and investing more than 15% of income towards retirement or other priorities. Repaying the mortgage sooner get my vote, even if the overall outcome is worse than investing, for three reasons:

The return is risk-free and equal to the interest you save.
Building more equity gives you more options when it comes to moving home or changing mortgage, with cheaper deals for those with a lower loan to property value.
When stockmarkets next plunge you'll be less worried and anxious than would be the case if you invested surplus income rather than overpaying your mortgage.
Knowing you own more of your home can be emotionally rewarding. And having no mortgage payments is a wonderful situation to be in.

In a Nutshell

Investing in real assets like property and shares makes a lot of sense for your long-term financial wellbeing. But you need firm money foundations first, to be able to weather the inevitable ups and downs that are the entry price of investing.

And avoid speculating unless you like eating cat food, because the chances are that's what you'll be eating in later life if you do.

When You Shouldn’t Invest

Speculating