How is wealth created?

Have you ever looked at the back of a £20 note? I suspect that all of you have, but if you look more carefully you will see the face of a gentleman called Adam Smith.

Now Mr Smith gets as much advertising space as the Queen (whose picture is on the other side in case you hadn't noticed!) because whilst he lived in 18th Century England he was possibly the greatest economist of all time and wrote a book called the Wealth of Nations.

In that book he details "How Wealth is Created" and once you truly understand this you can stop making investment mistakes and taking risks that are not worth it, whilst taking some that are. He explains that in order to create wealth you must have four elements.

Natural Resource
Intellectual Property
Skilled Labour
Capital (Finance)

So if we take Gold as an example of a Natural Resource you then need somebody with the knowledge of how to extract it from the ground (Intellectual Property) and in turn he would employ a skilled labourer to mine it. What he now needs is financing or a Capital injection of cash. Once all of this is in place the mine can be built and the miners employed and the gold extracted and sold to generate more cash to make the whole process keep turning.

This process is known as Capitalism and any investor taking part in capitalism is owed a return from the profits made on the sale of the gold. Now the mine owner can either get his Capital from the bank (and pay hefty interest) or he can get it by selling shares in his company to you and I. If we buy those shares we now own some of the company and if it makes a profit so will we.

So an investor looking to create wealth must take part in capitalism as it is the ONLY way that money can be made. Obviously you wouldn't want to invest all your money in one Gold mine, but by spreading your investment you can reduce risk. I will tell you how to do this another time.

You can find out loads more about Adam Smith at http://www.adamsmith.org/