Wealth erosion is the decline of one’s asset holdings over time. It is a natural process that all investors eventually experience, but it is possible to minimize the amount of wealth erosion by diversifying one’s portfolio and making wise investments.
Wealth erosion occurs when an investor’s portfolio loses money through market fluctuations or paying cash out of their portfolio for taxes, fees, and other expenses. The first type of wealth erosion is market fluctuations, and the second is spending money out of the portfolio rather than into it. Markets fluctuate, and investments can lose money in the process. This is called market risk. If a person leaves their money to grow in an investment with little movement or volatility, they will not see any wealth erosion; however, if they tried to time the market or put all their eggs in one basket, like a real estate investment or small-cap stocks than the result could be adverse.
Wealth erosion could also be defined as a fall in the value of money or reduction in the accumulated wealth, i.e., investment funds. There could be many reasons for this. For example, the decrease could be due to more consumption than saving, eroding the purchasing power of the money, high taxation, having a high percentage of fixed income investments than required, etc.
What are the Causes of Wealth Erosion?
There are many causes of wealth erosion, some of which are inevitable. The causes include:
- Inflation is the most common cause of wealth erosion and happens when prices increase for goods and services.
- A decrease in investment income occurs when investments produce a lower return than expected or expected future rates.
- Dividends or interest payments – when these payments decrease from the previous year, it can lead to wealth erosion because less money will be available for reinvestment.
- Decrease in asset values – this can happen if an asset’s value decreases from one year to the next, which can lead to a reduction in your net worth. For example, the stocks and bonds you own fluctuate in value over time. So, for example, this year, investments may be worth Rs 10 Lakhs, but next year, the same assets may only worth Rs 8 Lakhs.
How to Avoid Wealth Erosion in Your Investments?
When you invest in the stock market, you are investing in companies. Some companies have a history of not being long-term stable entities. Rapid technological developments make companies quickly obsolete. There could be other reasons like management issues, new product lines, shrinking markets, etc.
The best way to combat this for companies you invest in is to diversify your portfolio with stocks of multiple companies, bonds, mutual funds, ETFs, etc. Then, if any company goes bankrupt, you can cover the loss. Further, If you are losing money in one particular type of investment, it’s better to switch investments rather than hold on and hope things will improve.
How to Prepare for a Worst-Case Scenario & Protect Your Wealth?
The best way to prepare for a worst-case scenario is to have an investment strategy.
Investing in the stock market can be a risky business. But it is also one of the most rewarding and profitable ways to grow wealth. Investors should have a plan before they jump into the market.
An excellent place to start would be by researching different investing strategies and determining which one is best suited for you, given your risk tolerance and financial goals.
Conclusion: Healthy Investing Requires Worrying About Risk
Investing can be complex and is not an easy thing to get your head around, especially with all the variables involved. Don’t make avoidable mistakes; look for safe investments and research market conditions before investing. There are many avenues for learning about investing through books, workshops, or other personal research.
