Shockingly, one survey found that 40% of Americans fear retirement more than they do death! Oftentimes, our money fears, like this one, stem from a lack of understanding and planning. But, when you comprehend the steps you need to take throughout your financial life cycle, your fears will ease and you’ll be more prepared to build wealth that lasts!
When it comes to the financial life cycle, money serves a different purpose in each phase. Depending on where you are, your primary aim may be to save, spend, or even give. Nevertheless, understanding the stage you’re in as well as the ones that lie ahead allows you to prepare for what’s next. Not only will that boost your confidence, but it will also eliminate stress and help you have a happy retirement!
What is the Financial Life Cycle?
Throughout your life, you have different goals for your money. Early on, it’s living below your means, saving, and accumulating assets. As your wealth grows and you approach retirement, your money mindset shifts to a more conservative approach. Once you stop working and are financially free, you begin concentrating on a decumulation strategy that makes your money last. If you’ve been successful in each of the previous stages, then you’ll need to consider the legacy phase, too!
Even though most stages of the financial life cycle overlap, they can still be broken down into 3 main ones. Having said that, here are the 3 phases of your financial life cycle and how you can be successful in each one!
Stage #1 – The Accumulation Phase
The first stage of the financial life cycle is the Accumulation Phase. You enter it once you start working and earning money.
For most people, the Accumulation Phase is the longest stage of the financial lifecycle. It’s common to spend multiple decades working, saving, and creating wealth.
For one reason or another, many people get tripped up early in the Accumulation Phase which keeps them in it longer. Rather than accumulating assets, they accumulate liabilities. They try to keep up with the Joneses by splurging on status symbols which puts them into debt. Now, they’re not just wasting money on interest, they’re handcuffed to their job for the foreseeable future, too!
Another common money problem in the Accumulation Phase is being financially underprepared. When you don’t have rainy day savings or an emergency fund, a large sudden expense can cause financial havoc. It can force you to borrow money and get stuck in debt!
In the Accumulation Phase as well as throughout the financial life cycle, it’s important to maintain a strong financial foundation. With it, you’ll be better protected from financial surprises. Not only that, but it will also provide peace of mind as you take risks and start building your net worth up!
Despite what society wants you to believe, you don’t have to spend the majority of your life stuck in the Accumulation Phase. The amount of time you’re in it is based on your savings ratio. If you can keep your burn rate low, then you’ll stockpile more money. With it, you can acquire more assets which in turn allows you to become independently wealthy faster!
Another consideration in this stage is determining the types of accounts to use to grow your nest egg. If you want to retire early and you’re only contributing to traditional retirement accounts, then you may face large penalties and fees when you make withdrawals.
Having said that, some portion of your wealth should be held outside of traditional IRAs and 401Ks. You could hold stocks in a brokerage account, buy real estate, or other alternative assets. Either way, holding assets outside of traditional accounts gives you more flexibility and allows you to access the money without incurring unnecessary costs!
Throughout the Accumulation Phase and beyond, you should keep your finances in order and manage your money well. Otherwise, you could get stuck and end up working forever!
Stage #2 – Wealth Preservation Phase
As your working years start to wind down, you enter into the Wealth Preservation Phase. At this point, you’ve been working, saving, and investing for years. Experiencing a personal financial crisis this late in your career could turn out to be disastrous!
The Wealth Preservation Stage consists of the last few years of your career up until the end of your life. At the beginning of this stage, you start taking steps that will reduce your risk and solidify your retirement income.
Depending on your risk tolerance, you may transition from a portfolio of equity investments into one that’s focused on bonds and other fixed-income products. In doing so, you’re moving from assets that are more volatile to ones that are more stable and predictable. This way, your retirement income will have little variation which helps you create a reliable spending plan!
In many ways, preserving your wealth is just as if not more important than creating it. After all, your working years are behind you and if you live long enough, you risk running out of money. Having said that, the key to success in this stage is making your money last!
Asset Decumulation
In the Accumulation Phase, you’re building wealth whereas during decumulation you’re spending it down. You’re figuring out how to turn the assets you’ve accumulated into income, so you can satisfy your monthly expenses with ease.
Depending on your financial strategy, you may have acquired assets that produce mailbox money each month. As long as they cover your bills, then it likely doesn’t make financial sense to get rid of them.
But if you’re like most people, you’re going to have to sell a percentage of your portfolio each year. In doing so, you’ll receive distributions from your retirement and brokerage accounts which will be your income. Distributions from retirement accounts get taxed as ordinary income whereas the financial gains in brokerage accounts get taxed as capital gains.
In this stage, your spending determines the amount you need to decumulate as well as how long your money will last. The more you spend, the less time your assets will sustain you!
While spending is within your circle of control throughout the financial life cycle, the state of the financial markets is not. You have no control over their performance or the rate of return you receive.
With that being said, one of the largest dangers you face early in this phase is sequence of return risk. It occurs when financial markets take a nosedive early in your retirement, forcing you to sell a larger percentage of your assets to cover your bills.
For example, imagine your retirement lifestyle costs $60k per year. Using the freedom number calculation and a 4% withdrawal rate, you need to amass $1.5 million in assets. However, if the market falls and your portfolio sinks to $1.2 million, you have to withdraw 5% of your portfolio to produce a $60k income. While this may not seem like a big deal at first, withdrawing a larger percentage of your assets puts your entire portfolio’s longevity at risk!
One simple way to combat sequence of return risk is by holding a larger percentage of your assets in cash. A common money rule of thumb is keeping 12 to 24 months of expenses liquid. This way, if the market falls, they can rely on their cash to pay bills without touching their portfolio. Because of this, their money stays invested while the market and their portfolio have time to recover!
Also, if you haven’t done so already, it’s time to get your estate in order. Not only will you need to choose an executor, but you’ll need to determine who gets what and when. Depending on your situation, there may be other end-of-life considerations, too.
For many people, the ultimate goal of the Wealth Preservation Phase is leaving behind legacy wealth. They want to feel like their life mattered and that they made a positive impact on others. Not only while they’re on Earth, but also after they’re gone.
Stage #3 – Legacy Phase
The final stage of the financial life cycle is the Legacy Phase. Although it’s your choice, many people decide to leave something behind when they pass.
When it comes to leaving a legacy, it’s common to think in terms of generational wealth. Many people choose to spend their time on Earth amassing fortunes and leaving them behind, making the lives of future generations easier. Not only that, but you could also make charitable donations or support causes that are near and dear to you!
Truth be told, leaving a financial windfall isn’t the only way you’re going to leave a legacy. Your contributions to society, the positive impacts you have on others, and the time you spend with family and friends all contribute to the way people will remember you.
Even though it’s somewhat morbid, thinking about your legacy now can help you determine the best course of action forward. Just like setting SMART financial goals, when you begin with the end in mind you can figure out the steps you need to take to get the result you desire most!
Throughout the financial life cycle, it pays to check in with different financial professionals from time to time. They can address your needs and concerns as you transition from one phase into the next. Besides that, they can also uncover your financial blind spots. Not only will that help you stay safe, but it will keep you on track toward your goals, too!
No matter which phase of the financial life cycle you’re in, the key to success is continuing your financial education. As long as you keep learning, you’ll gain valuable money skills that will pay off time and again on the journey toward your dreams!
Which stage of the financial life cycle do you feel least prepared for? Comment below.
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