The Smart Way to Think About Risk Management When Building Wealth
The Smart Way to Think About Risk Management When Building Wealth
Disclaimer: This article contains general information only and does not take into account your personal objectives, financial situation, or needs. It is not intended as financial, legal, or taxation advice. You should seek advice from a qualified professional before making decisions about your own situation.
When people think about building wealth, they often imagine big risks—buying speculative shares, jumping into the latest investment trend, or leveraging heavily into property. While some individuals do succeed this way, many wealth-building stories follow a more measured path that prioritises risk management over risk taking.
Below is an overview of some commonly observed approaches and principles that people have used to grow wealth while keeping risk in check.
1. A Common Wealth-Building Pattern
Looking at how many business owners and investors have grown their wealth over time, a recurring pattern emerges:
Building a profitable business
Business ownership often plays a major role in wealth creation because it allows people to leverage their skills, networks, and industry knowledge.Allocating surplus profits into diversified, lower-risk assets
Some business owners choose to take profits out of the business (beyond what is needed for reinvestment) and place them into investments such as:Broad-market index funds
Income-producing property
Other diversified, transparent assets
Taking higher risk with smaller allocations
Riskier ventures—start-ups, speculative shares, or other niche opportunities—are often funded with capital that an investor can afford to lose, keeping the core wealth base protected.
This style of approach separates core, long-term wealth from higher-risk opportunities, allowing for growth without placing all assets in a single risk environment.
2. Different Investment Philosophies
There are two broad investment approaches that people sometimes consider:
Index-based investing – This approach seeks to match the market’s overall performance using low-cost index funds or exchange-traded funds (ETFs). It offers diversification, relatively low costs, and requires less ongoing research.
Active, selective investing – This involves researching individual companies and investing only in those judged to be “good” opportunities based on factors like quality, growth prospects, and valuation. While this may outperform the market in theory, it requires significant time, knowledge, and expertise, and can be difficult to execute consistently—many professional fund managers do not outperform index returns after costs.
For some, the simplicity and diversification of index investing is appealing; for others, the challenge and potential reward of active investing is worth the effort.
3. Managing Costs to Manage Risk
Investment costs—such as management fees—reduce your returns every year. Unlike market performance, which is uncertain, costs are predictable and can be managed. Over long periods, even small fee reductions can have a significant effect on total wealth due to compounding.
4. The Role of Tax Efficiency
Tax is another factor that can impact investment returns. Approaches that some people consider include:
Making use of tax-effective structures such as superannuation
Timing the sale of assets to manage capital gains tax
Accessing eligible deductions and offsets
The effect of tax minimisation strategies varies greatly between individuals, and professional advice is essential before making changes.
5. Compounding: The Time Advantage
Compounding occurs when investment returns are reinvested, allowing future returns to be earned on a growing base. The longer investments have to compound, the more powerful the effect.
For example, an investment made 10 years earlier can potentially result in a significantly larger portfolio by retirement age compared with starting later, assuming similar returns.
6. Bringing the Concepts Together
Risk management in wealth building does not necessarily mean avoiding all risk—it’s about balancing opportunity with protection.
Some investors have found value in:
Growing business income as a primary wealth driver
Moving surplus profits into diversified, lower-cost investments
Keeping higher-risk investments as a smaller portion of their portfolio
Considering tax and cost efficiency to enhance returns
Starting early to take advantage of compounding
Every person’s circumstances are different, so while these ideas may be part of a general framework, the right approach will depend on your goals, resources, and risk tolerance.
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