Finance Wanted.

By Vincent Cooper

In the world of money and profit one of the biggest pitfalls is to be taken in by the promise of "Don't worry. Everything will be okay. It's guaranteed to succeed." We all want to believe in our own success and we all want to take a positive attitude towards attaining success, whether it is financial or otherwise. It is easy to find ourselves persuaded by others - indeed, it is easy for us to persuade ourselves - that this investment will give us the money we want and, by extension, the lifestyle we want. In pursuit of financial dreams it is too easy to leave commonsense behind and set off into a distant land we have never visited before and of which we have no real idea if it is safe or not.

Now let me be clear: No investment is without risk. That's right. No investment is without risk. That includes the money you put into a bank. It's highly unlikely if you live in a first world nation, but it is not impossible for that bank to suffer severe problems that cause it to fold, with you losing all of your money. A basic rule of investing is simply this: the more potential profit, the more potential loss. In other words, with greater risks comes the possibility of greater profit. But if things turn badly for you you stand to lose a great deal too. Maybe everything. So before making any investment it is crucial that you weigh the risk to reward ratio and determine how willing you are to stand the risk (psychologically as well as financially).

Under no circumstances should you risk more than you can stand to lose. This may seem an obvious point to some, but with the heady promise of easy profits, a lot of people forget this and put everything they have into a venture only to see it fall flat. Perhaps every once in a while you hear of someone who risks it all and gets the reward. These stories are great. They are inspirational and develop in us all a sense of a 'can do' attitude. But as with everything else in the media, you are only hearing about the stories that are unusual and that stand out against a drab background of sameness. You know, the stories that generally don't happen in normal life. No-one wants to read about a man who lost everything in a business venture that went sour. Why? Because it happens everyday. As unfortunate as it is for the individual concerned, for the public that the media depends on for advertising revenue, stories of business failure would very quickly become matter-of-fact and nothing special. So evaluate the risks carefully on a case-by-case basis and don't be swayed by the uncommon success of one or two people that you hear about.

And this brings me to the main point I want to make.

Mentally you need to have a very clear demarcation between your cash reserve and your capital. Preferably though, this should extend beyond a mere mental difference and mean that you have taken the trouble to set up two separate accounts to avoid the temptation of 'borrowing' from your cash reserve to bolster your capital.

Your cash reserve is a form of accumulated savings and should be placed in a low-risk investment fund. The purpose of having this reserve is not strictly speaking to use it as an investment (though you will slowly acquire interest payments) but to serve as an emergency fund should you be in need of cash at short notice. The money should be liquid, meaning you can get instant or almost instant access to it. Your cash reserve is not your savings as such. It is not saved to do anything, such as pay for a holiday or a new car, except serve you in an emergency. Once accumulated it should not be touched. Aim to build your cash reserve so you have six months of living expenses saved and add to that total thereafter at whatever pace you can afford to.

Your capital on the other hand is the money that you will use to work for you. Your capital is the money you can afford to lose. Without forgetting to be sensible, your capital can be used to secure loans, buy real estate, invest in the stock market or to open a business. If any of these ventures don't turn out the way you had hoped, well, as bad as that is, it should not be the end of the world. Why? Because you have maintained your cash reserve. You still have money saved to fall back on.

The difference between your cash reserve and your capital is crucial if things go badly. If you have used your cash reserve in conjunction with your capital and things don't work out then you stand to lose literally everything. Some even go so far as to use their home as collateral. Big mistake. Never, never, never risk anything that you can't afford to lose without affecting your basic need for food, clothing and housing. Do not put yourself or your family in a position where your life becomes miserable because you have incurred losses that are unsustainable. Take calculated risks, but take those risks with your capital, not your cash reserve.

To sum up then. A simple financial plan for you to begin implementing immediately is to distinguish between your cash reserve and your capital. Your cash reserve should be able to cover six months of living expenses (specific living expenses will vary from person to person and family to family) and should be placed in an account that is low-risk (and most likely therefore with a low return). You should be able to get to this reserve of cash instantly if you need to so whatever savings method you use, it should allow for liquidity. Add to this cash reserve as and when you can, but don't touch it unless you really need to, and certainly don't use it for any risky investments.

Your capital by contrast is money that you can afford to lose and is identified by you for the specific reason of having it work for you to earn you a greater profit. While still paying attention to and evaluating investment opportunities and sorting the good deals from the bad, use your capital to build greater and greater profits for yourself and your family. If you suffer a downturn, don't fret too much about it. Learn your lesson and determine what happened so you can avoid re-experiencing the same result in the future but never forget that you are not going to bankrupt yourself because you have your cash reserve sitting patiently for you, waiting for when you need to access, if you ever do.

Strictly distinguishing between your cash reserve and your capital is an important first step to gaining financial security and thereafter financial freedom. Consider the two factors and begin making the changes in your life today to incorporate a division of your money.

Vincent Cooper is the owner and webmaster of Personal Development Forum, a site dedicated to personal development and growth. In addition he works as a coach, drawing on his vast experience and understanding of Asian culture to create a unique approach to self-growth and spiritual insight. To find out more about his innovative philosophy of development click here