My Comments: As a financial planner, I’ve described the three primary phases most of us travel through in life: childhood, adulthood, and retirement. As a child, we’re dependent on others to maintain our lives; as adults we’re dependent on our ability to fend for ourselves and typically work for money; in retirement we’re dependent largely on our earlier ability to set aside resources and have money work for us.
These words from Sunita Abraham break down ‘adulthood’ into four financial stages and they are worth noting. Even if you’ve already retired, you may find it interesting for yourself and others in your family.
by Sunita Abraham \ October 10, 2018
Having a different financial planning strategy for different stages of one’s life cycle can help simplify the task of investing for various tenures
If the laundry list of “things to do” puts you off financial planning, then here is a way to make it easier. The elements that form part of the financial planning exercise include budgeting to generate savings, investing for goals, securing , protecting income through life and general insurance, managing debt and planning for the transfer of wealth.
While each element plays an important part in securing your finances, not all of them are equally significant at every stage in the life-cycle. Categorize the activities as critical, important, urgent and optional in each phase of your life. Focus your resources on those activities that are identified as critical and important that need immediate attention. Consider activities that are labelled as urgent only if they are also seen as essential. For example, while you may consider holding off increasing contribution to the retirement corpus in favor of paying life insurance premium, you should not consider doing it to fund a holiday even if it is urgent.
We tell you the four critical stages in a life cycle and how different financial planning approaches and tools can fit into each to make it a smooth ride for you.
The first income stage
When you first begin earning an income, budgeting is the critical financial skill that you need to master. Develop a suitable budget and build the discipline to live within your income so that you don’t fall into a debt trap. Once you learn to contain your expenses to available income, start building savings into your budget. The emergency fund will have the first claim on your savings and this is an urgent and important task.
Initiating some investments for retirement is an important task at this stage even though the goal may seem too much in the future to be relevant now. Investments for other goals are optional at this stage and can commence once your income and savings stabilize.
Unless you have dependents on your income, life insurance is optional at this stage and you need not assign scarce funds for life cover. However, a basic health insurance is important, particularly if you don’t have a health cover from your employee. Other products such as auto insurance and personal accident insurance should also be included as required. Servicing debt that you may have, such as student loan, is an important element, as is controlling debt use and building your credit history. A misstep can have long-term consequences on your borrowing ability in the future.
Estate planning is optional at this stage and you can consider it in the future when wealth has been created.
The dependents stage
This is the phase that is the most demanding since many of the elements of financial planning need to be serviced. You are likely to have dependants on your income and, therefore, life insurance is a critical element for security. Consider term insurance which gives you the required protection at the most efficient cost. Expand health insurance to cover your family too.
Your income and expenses would have both expanded and you should be better at budgeting and saving by this stage. Living by the budget is critical to be able to find the savings for the many short-, medium- and long-term goals you are likely to have at this stage. Revise and fine-tune your budget periodically to reflect your income and need for savings. Invest the savings to construct a portfolio that is aligned to growth, income or liquidity needs of goals.
Use a professional to help you do this efficiently if you find yourself procrastinating. Build basic estate planning into your finances by making clear nominations on your investments and insurance.
Debt management is a critical function at this stage given that your needs are likely to be more than availability of funds. Keep your ability to repay in mind while adding debt and ensure you do not harm your credit score or credit history. You should not have to meet debt repayment obligations at the cost of your retirement savings, insurance protection and essential goals like housing. Borrow primarily for appreciating assets where it will help grow your net worth over time.
The growth stage
If you have managed your personal finances prudently so far, then this will be the golden stage for your finances. Your income would be high and seeing an upward growth trend, while your expenses would have stabilized resulting in growing savings. Being mindful of expenses is important even at this stage and the focus of budgeting would be to maximize savings.
Managing investments is critical in this period. Many of your goals would be close to being funded and the investments have to be rebalanced to reflect this. This is also the time to catch up on important goals like retirement with the excess savings being assigned to this. Where the goals are well in the future, the investments should reflect the ability to take risk to earn higher returns.
Life and health insurance should be updated and aligned to your situation.
Now that you have accumulated wealth, take time to plan how you would like to distribute your estate and formalize a Will. Make sure that the assets and investments do not have nominations that are contrary to what you have decided in your Will.
Servicing debt should not be difficult at this stage given the high income. But consider the funding needs of your other goals before you add to your debt burden.
The retirement stage
Budgeting becomes the focus of finances once again during retirement. The object now is to control expenses to stay within the available income. Managing the investments to generate income and protect the corpus from inflation becomes the primary investment activity at this stage.
Adequate health insurance is critical since health costs can throw your income off rails. Life insurance may be relevant only if it is required to protect retirement income for the spouse and debt should not be a big part of your finances at this juncture.
An important activity at the beginning of retirement is to simplify finances. This would include cutting down on multiple accounts and investments, organizing documents, updating details and consolidating investments to a few relevant ones. Make sure all your financial documents are updated and accessible.
Make optimum use of limited time, funds and energy by concentrating on the activities that are important and critical at each stage in your life. Over time you will find that you have knit together all the elements without finding the whole exercise too intimidating.