Financial Plans Evolve Through Every Stage of Life
A financial plan must evolve with your goals, family and income level. Here's a look at how three key areas of your financial decision-making change as you move through life.
A financial plan is like a house; it was never intended that one model would fit all your needs over the course of a lifetime. Instead, your plans must evolve over time as your goals, your family and your income level change. While your principles remain the same throughout your life, the tactics you use to achieve your financial goals change with the decades.
Here's a look at how three key areas of your financial life – investing for retirement, life insurance, and estate planning – evolve as you move through the young adult, middle-aged, and retiree stages of your adult life:
The 401(k) Is Key
Your primary financial decisions revolve around launching your career, getting married, having children, buying a first home and, perhaps, paying off student loans. You’re not earning very much yet, but it’s still time to start thinking about investing for retirement.
For most younger people, the crucial decision is to become fully invested in your employer’s 401(k). A simple paycheck deduction makes it easy to save, and employer matches can double what you’re putting away.
There’s an old rule of thumb that the percentage of equities in your retirement account should equal 100 minus your age. Thus, at 25, you’d have 75% stocks and 25% bonds in your portfolio. Some surveys have shown that millennials are reluctant to invest in stocks, since their first real exposure to the stock market was the fallout from the crash of 2008–09. But this is when you should be thinking long-term, to realize that even if you do incur some losses, there’s plenty of time left to make them up.
The Earlier the Better
For young adults, the earlier you buy life insurance coverage, the cheaper it is, for what should be obvious reasons. It also tends to be cheaper for people who are not yet married or have children.
You’re also likely to be at your healthiest at a younger age, which keeps the cost down. Even if you still feel fine, things like cholesterol problems may begin to show up on blood tests in your early 30s, complicating your ability to get the best deal on life insurance.
It’s for the Kids
Finally, there’s estate planning. Basically, as soon as you have children, it’s time to start at least thinking about your estate plan. The first step is to name a legal guardian to take care of them if you and your spouse are unable to do so.
Or if you have health concerns that may eventually limit your professional life or even your lifespan itself, it’s never too early to start thinking about a durable power of attorney and a health care proxy as well. These too can be the first building blocks of an estate plan.
The 100-Minus Theory
As you settle into middle age, harking back to the rule of 100 minus your age, your investments for retirement should approach an equal balance of stocks and bonds. From there, you can modify it based on your objectives, your risk tolerance and your sources of income.
Your 50s are also a good time to start building a tax strategy for your retirement. One idea is to think of your retirement contributions as going into three buckets: taxable, pre-tax and post-tax. Any investment without a tax advantage, such as buying a mutual fund, is in your taxable bucket. A 401(k) or IRA, where money is typically contributed before taxes are taken from it, constitutes the pre-tax bucket. The post-tax bucket is your Roth IRA – money that had been taxed when you contribute it, but is tax-free when you withdraw it. Now is a good time to assess what your tax situation is currently and what it’s likely to be in retirement, and save accordingly.
Converting Your Policy
In middle age, you may want to look into converting a term life insurance policy, which expires at a certain point, into permanent life insurance, which builds up a cash value. Term life is cheaper to buy when you’re just starting out as an adult, but it will need to have a conversion feature in order for you to make it permanent.
This is also the stage of life during which you should start thinking about long term care insurance. Like life insurance, long term care insurance is cheaper the earlier you buy it, and you never know when you are going to need it.
Time To Make It a Reality
Estate planning becomes more concrete at this stage. Now is the time to start thinking about creating a vehicle for your assets, such as a trust, to ensure that as much of them as possible are distributed to your heirs. Many people at this age also have elderly parents who need to be cared for. If you have significant responsibility for your parents’ well-being or financial stability, you may want to include them in a trust as well.
From Growth to Preservation
When it comes to investing, things are tricky for retirees or near-retirees. Now you have to worry about the risk that you will run out of money; about a quarter of today’s 65-year-olds will live past 90, which means a good 25 years in the retirement phase of life.
In one sense, your investment goal shifts at this point from growth to preservation, but if you’re going to live another 25 years after your work income ends, you’ll need some growth as well. You’ll want to shift more – but not all – of your assets into bond and money market holdings.
You’re also more exposed to market drops, and not just because you have less time remaining to make up for them. When you’re working and saving, dollar-cost averaging means that if you invest the same number of dollars each month, you buy more shares when the market is down, which helps build your nest egg. But the same factors work in reverse in retirement: To get the same monthly income, you have to sell more shares when the market is down. So when the market rebounds, your money is no longer there to grow along with it.
Winding It Down
One positive development: As you move into retirement, you may not need as much life insurance. When your children are no longer your dependents and you’re no longer in the workforce, life insurance coverage isn’t as critical as it once was.
This is when permanent insurance, with its cash value, can make increasingly more sense than term insurance. If you’re interested in owning a permanent life insurance policy, know that the cutoff age for that usually kicks in at around 75 or 80.
Finalizing Your Legacy
As you reach retirement and your working years come to a close, your assets often settle into a type of stasis, which provides a good opportunity to finalize your estate plans. Your family may well have settled into something approximating a final form as well. You may also want to start giving away assets from your estate for tax and other reasons.
This is just the beginning of how a well-constructed financial plan will evolve over the course of your life. Every step of the way, we can help you create plans that suit whatever house you happen to be in.