Financial Strategies and "Life Cycle" Planning

The best saving and investing habits pay off throughout life. Yet, with age, it is probable that an individual’s specific financial goals are likely to change. "Life cycle" planning identifies both common goals and investment strategies for the key stages of adult life. This knowledge can help individuals when examining and reassessing their particular portfolio requirements.

Starting Out

From ages 25 to 35, common financial goals often include saving for a down payment on a first home, establishing a college fund for young children, and putting away funds for retirement. But common financial goals often create competition from perhaps limited income resources. Therefore, it is imperative that you spend the time necessary to rank your financial goals in order of importance. For example, do you slow down saving for a home in order to put enough money away for a child’s education needs?

With a longer planning horizon, younger individuals may have the opportunity to enhance their investment returns through the effects of compound interest, tax-deferred growth, and possibly a relatively high risk tolerance.

To secure a comfortable retirement, individuals at this stage would do well to start saving as early as possible. They should consider contributing the maximum to an employer-sponsored plan, such as a 401(k) plan. Many companies match all or a portion of employee contributions, which will further enhance long-term results. Individuals who do not participate in employer-sponsored plans should consider taking advantage of Individual Retirement Accounts (IRAs). In either case, contributions and earnings are taxed only when withdrawn. (Note: A Roth IRA accepts after-tax contributions. Qualifying distributions are not taxed.) In addition, the income tax benefits may allow individuals to retain more of their discretionary income.

It is important to follow a diversified investment strategy that conforms to your long-range retirement planning goals. A well-diversified retirement portfolio will have assets placed in different types of investments and investment classes that cover a wide range of the risk/return spectrum. Examples of some investment vehicles include stocks, bonds, mutual funds (which can include stocks, bonds, or a combination of both), certificates of deposit (CDs), savings, and money market accounts. Each investment class, and its respective options, tends to react differently to changes in financial markets and to the economy as a whole. Thus, by diversifying your portfolio, risk is spread over a broader range of investments, potentially minimizing the impact of downturns in the economy or a particular market sector.

When determining how to allocate assets in a well-diversified portfolio, younger individuals are well-positioned to think "growth" by emphasizing equities. Although common stocks generally tend to be riskier than other investments, over the long run—say, twenty-five years—they have historically yielded higher returns. Of course, investment returns and principal values of stocks and stock mutual funds will fluctuate due to market conditions. Therefore, when shares are redeemed, they may be worth more or less than their original cost.

It is important to keep an eye on the "big picture" when it comes to asset allocation. Looking at the big picture means incorporating all assets (such as personal savings, home equity, and retirement plan funds) when determining the best investment mix.

The Peak Earning Years

During the period from ages 35 to 55, saving for a child’s college education often becomes a higher priority. As earnings increase, many individuals may want to "trade up" to a larger home or make another major purchase, such as a vacation home. Moreover, as the years pass, the need to boost retirement savings becomes a more pressing reality.

The key to a solid investment approach may be to continue to take advantage of the potential growth produced by an equity-dominated portfolio. Ultimately, it may be wise to gradually begin introducing income investments. Bond or stock and bond funds may help produce valuable income that can be used to help pay for a child’s college expenses or to help diversify a portfolio.

With personal income at its height, it is also important to maximize tax-deferred qualified plan contributions and take advantage of the tax benefits offered by annuities and tax-exempt securities.

Nearing Retirement

Between the ages of 55 to 65, the emphasis is generally on safeguarding accumulated assets. Another goal is to reduce overall debt, such as from college expenses or a mortgage, to take advantage of extra discretionary income to help increase retirement savings.

As the planning horizon shortens, the watchwords are "asset preservation." A typical portfolio strategy involves shifting a larger portion of assets from equities to more conservative fixed-income securities to achieve a better balance between growth and income. Income mutual funds, bond funds, and annuities can all play important roles in balancing a portfolio.

If earnings remain high, attention should also be given to help reduce tax obligations. This may be accomplished by adding tax-free bond funds to the investment mix. As grandchildren arrive, grandparents may want to allocate assets for them or consider the benefits of gifting.

Retirement Years

After age 65, the primary financial focus is generally on generating a steady income stream and protecting it from the ravages of inflation and taxes. As salary or wages decrease or stop, investments must produce sufficient income to help supplement Social Security and pension benefits.

As an investment strategy, a retiree’s portfolio should place a greater emphasis on income-generating stock and bond funds and annuities. However, growth stocks and mutual funds should not be entirely discounted. Growth-type investments can still serve a useful purpose in the battle against inflation. Also, with the increased life expectancies of individuals today, retirees may still have a long-term investment horizon for a good portion of their savings. Taxes may still remain an issue for retirees with unusually high income. In such cases, tax-free bonds can help reduce tax obligations.

Securing the Future

The "life cycle" approach can help individuals chart a course to financial success. By understanding the needs that are common at different life stages, you may be in a better position to choose the most appropriate savings and investment strategies for your situation. Always remember that investing involves risk. There are never any iron-clad guarantees. And, while past performance is informative, it can never be studied with the assumption that historical profits will mean similar gains in the future. Therefore, it is the actual knowledge of how investments work and what potential benefits they can provide which will help you determine your ability to accept the risks, and hence, sleep more comfortably each night.

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