As someone who has been working in the financial services industry, primarily focused on financial planning, for as long as I have, some patterns have started to emerge, patterns which define our journey through life from a financial standpoint. While it’s true that everyone’s experience in life is a little bit different, and each of our own financial odysseys are no exception, there are some discernable markers, if you will, that most of the clients we work with have passed through along the way. As I’ve thought about this a bit more, I’ve distilled it down to the four crucial phases of a financial lifetime.
Phase 1 – Just out of College: We start with the first years out of college because, from a financial standpoint, that’s when things begin to get interesting for most people. Your parents are no longer willing to foot the bill for you, or cover your mistakes, so this is the time that most people truly start to feel the pressure of financial responsibility.
For many, the first financial reality at this stage is a large amount of student loan debt. This also tends to be the time when consumer debt is taken on. Maybe your parents helped you get a credit card in college, but in these early working years when your income might not be very high, you’re paying rent and trying to service student-loan debt, and also enjoy life as young people tend to do, it is not uncommon to resort to the use of consumer debt to help fill the gaps.
In light of all of that, the story of phase 1, from a financial planning standpoint, particularly as we start to move towards phase 2, is all about paying down debt, and starting to build adequate cash reserves. We are often asked by folks at this stage (or by their parents), what is the best way for young people to start saving for retirement? But the answer often is that you shouldn’t start saving for retirement until you’ve addressed the issues of outstanding debt and cash reserves. What’s the point of investing for retirement, hoping to get a 7, 8 or 9% annual rate of return over time, if you’re paying 14% interest on a credit card each month? And if you don’t have adequate cash reserves, what’s likely to happen if you lose your job? You’ll be pulling those funds from your retirement savings anyway, and might be paying taxes and penalties to do so.
If you are lucky enough to be debt-free, and can invest some discretionary income for the long-term, aggression is your ally. With so much time until retirement, you want to let volatility work in your favor. Invest a little each month, invest aggressively, and ignore the ups and downs.
Phase 2 – The first Good Job: The next phase tends to occur as we have progressed along in our careers to the point that we land that first good paying job. Maybe we bounced around a bit trying to figure out just where we want to be, and now have found a place that feels like the right path, and that, financially, seems to offer the potential to move to the next level in life – buying a new car and/or buying a house. This is also the stage where many of us begin to settle down, and things like marriage and children start to become a reality.
On the financial side, during this time, consumer debt has been eliminated, or at least significantly reduced, and student loan debt is either a thing of the past, or else feels completely manageable. That first good job might have a 401(k) plan, and while many at this stage aren’t necessarily contributing the maximum, hopefully we’re putting in that 3-5% needed to at least get the full matching contributions from our employer.
These years can also be marked by financial unpredictability, as one day we’re single and saving good money, and the next we’re married with two kids, and trying to figure out how to pay for private school.
As we progress through phase 2 and into Phase 3, we hope to have a good foundation of retirement investments going, a solid three to six months of living expenses as cash reserves, and if necessary, a good base of college savings started for those kids, who are almost ready to use them.
From an investing standpoint, we continue to have a long way to go, so we’re still moderately-aggressive, but we’ve diversified a bit further, as the volatility of markets tends to affect us just a touch more than it used to.
Phase 3 – Peak Earnings: Here’s where things get crucial for retirement. By now, our earnings potential has reached maximum capacity, so our focus really zeroes in on how we’re going to replace our income stream in retirement. If we’ve done it correctly, the kids are almost done with college, the mortgage may not be paid off, but is on the back side of the term, and we’re making more money than we ever have. So it’s all about saving, saving, saving!
The interesting thing about Phase 3, though, is that this is a time when we quite often see wrinkles in the plan. Call it mid-life crisis, or whatever you care to, but we’ve had our nose to the grindstone for so long, that, for many, this is the first time we’ve had a chance to lift our heads up, and actually start thinking about what we want to do, rather than what we have to do. Maybe it’s just a new sports car, or maybe it’s going out on your own, and building a business, but it’s not unusual for these kinds of changes to occur at this time. The important thing to note is that the kinds of decisions we’re talking about now, can have a huge impact on your financial future, so think it through.
For others, it’s the time when we really start to envision what kind of retirement we want, and how much that is going to cost, so, from an investing standpoint, it’s all hands on deck: max funding our 401(K), and squirrelling every extra dollar of discretionary income into our brokerage account. As for our investments, as we get older, our tendency is to want to dial down the aggressiveness of our portfolio, and doing that little by little as we go is fine. However, we’ve still got some years until retirement, plus all the years in retirement, so we can’t get too conservative, or we risk losing the potential benefits of saving all of those dollars to inflation. The name of the game here is: invest as much as possible, as often as possible, and remain moderate to moderately-aggressive as you do.
Phase 4 – The Golden Years: Congratulations, you’ve made it! It’s all cruises, Hawaiian shirts, white patent-leather shoes and shuffleboard from here on out, right? Not so fast! You’re only 65 or 70 years old, and there’s a good chance that you’ll live until you’re 95. Are you really going to spend thirty years doing nothing but travelling and reading? Maybe. It sounds pretty good actually, but the reality is that most people don’t see retirement that way anymore.
Maybe you’ll want to work part time, or do volunteer or charity work. Maybe you’ll start an entirely new business, and have a whole second career in retirement. Chances are, no matter what you decide to do, it won’t look much like the retirement your parents or grandparents planned for.
It used to be simple…you retired at age 65, put all of your money in cash and T-bills and you were dead by 70. Easy peasy! Well, except for that dead-by-70 part. But today, if we’re looking at a 30+ year retirement, it’s not so easy. For your hard-earned money to last that long, you’re likely going to need some growth, and that means you’ll likely need to keep some risk (or potential volatility, more accurately) in your investment portfolio. And because of that, you’ll need to have a larger cash reserve, so that you can ride out any big market downturns that occur, particularly in the early years of retirement, without having to draw from of your portfolio when they do.
For the golden years these days, the keys are: two to three years of cash reserves, and keeping the investment portfolio working for you at moderate to moderately-
conservative, perhaps dialing it down incrementally as you get older.
So there you have it, the four phases of a financial life. It’s important to understand that these are extremely general observations and suggestions, and are not intended in any way to replace proper, targeted financial planning. They are merely my experiences, as a financial advisor, of what a successful, lifelong financial journey can look like.