MONEY TALKS – Time and again, prospective clients will book an appointment with us because they have a gut feeling that they are behind in life. As we move into adulthood; mortgages, daycare, groceries, and daily living expenses often reduce disposable income, making it harder to save for retirement, college, vacations, etc. Understanding exactly where you stand is a critical component when building a financial plan because it gives you a benchmark to measure success. At Lakeside, we use a Financial Life Cycle matrix to chart where clients are in comparison to their peer group based on age, net worth, and the size of their investment portfolio. Within the Financial Life Cycle, there are five main stages which you can use as a barometer to see where you stand.
Building the Foundation – This stage begins when you go out into the workforce and become self-supporting. Depending on your profession and educational background, this generally occurs sometime in your early twenties. For those in the foundation stage, annual income traditionally exceeds net worth (assets minus liabilities), since you don’t have years of savings under your belt. The emphasis in this stage should be to start saving for retirement and building an adequate cash & emergency reserve.
Early Accumulation – When your net worth grows to become larger than your annual income you officially move into the early accumulation stage, which is usually between ages 30 and 40. Since cash and emergency reserves have already been built up, the focus now is to start diversifying into stocks, bonds, and real estate. Purchasing the right-sized home and growing investments within retirement accounts (401k, IRA’s, etc) is critical to reaching the next level.
Rapid Accumulation – Typically between 40 and 55 years old, when your net worth is at least 3x your annual income and investment earnings exceed annual savings, you move into the rapid accumulation stage. The primary goal in this stage is to exponentially build your asset base by increasing risks and diversifying more into the equity market. An added focus should be put on maximizing tax efficiencies by optimizing investment location and proactive tax planning strategies to reduce taxable income.
Financial Independence – Normally, to enter the financial independence stage, your portfolio (retirement savings + brokerage accounts) should be at least 7x your living expenses, and your investment earnings should exceed half of your living costs. When entering this stage in life, which usually happens between ages 55 and 65 years old, you often have the ability to reduce your workload, change to a more rewarding career, or semi-retire. Any reduction in employment income is often supplemented with investment income. Transitioning to a more conservative portfolio helps to protect against large losses leading into the early retirement years.
Conservation – The conservation stage begins when you officially decide to stop working, which commonly happens between ages 60 and 70. At this point, your household’s investment portfolio should be 10x to 15x your annual living expenses. Rather than income from employment, income is now derived from pensions, social security, and investment earnings. The focus in the conservation stage shifts from a capital growth to a capital preservation model. Moving away from stocks and into bonds helps to minimize volatility thereby protecting your nest egg.
Determining where you are in your financial life cycle can be useful guide to help plan for the future. If your chronological age is well behind your financial age then some adjustments need to be made to get you back on track. The earlier you make these key changes, such as increasing retirement savings and maximize tax efficiencies, the more time you have to catch-up or even get ahead in your financial life cycle!