Personal Finance 101: How to Invest Through Your Lifetime
Our mini-series on personal finance continues by breaking out the various financial risks an investor can experience throughout their lifetime along with how affluence affects investment strategies.
Source: U.S News
One of the most important considerations in individual wealth management is life stage. Younger investors typically have a higher appetite for return and ability to take on risk. This changes as an investor ages – with retirees having a greater preference for avoiding investment losses. Retirees also have a preference for income over growth. The CFA Institute classifies life stages into seven categories: Education Phase (typically before age 25), Early Career (age 25 – 35), Career Development (age 35 – 50), Peak Accumulation (Early 50s – Early 60s), and Retirement (broken out into Pre-Retirement, Early Retirement, and Late Retirement). For the sake of simplicity - we will be focusing on investors in the Early Career, Career Development, Peak Accumulation, and Retirement stages.
Source: JMH Wealth Management[1]
Early Career Stage
This stage typically starts when someone enters the workforce – this most often occurs in a person’s mid-twenties but can begin as early as age 18 or as late as in the mid-30s. During this stage, a person is starting out their career and is likely focused on budgeting, debt management, saving for a deposit on a home, establishing financial security, and potentially starting a family. Some of the biggest risks for investors in the early career stage include uncertainty around career path resulting in potentially volatile earnings (earnings risk), the risk of earnings loss and other costs in the case of unexpected health issues or disability (disability and health risk), and risks of unplanned costs around assets such as cars (asset risk). To a lesser extent, individuals in this category also have to be aware of the risk of death of family members (premature death risk) and the potential risk of liabilities from injury or damage to others, for instance from a car accident (liability risk). To reduce the potential impact of these risks, investors can purchase insurance and start building an emergency fund. Below – we summarize the ways investors in the early career stage can protect themselves against each kind of risk.
Career Development Stage
The career development stage normally occurs from the age of 35 to 50. This phase can be identified as a period of specific skill development, upward career mobility, and growth in earnings. The primary objective for investors in this life stage is overall financial security. For individuals with children, an objective might include saving for college. Additionally, individuals are more focused on investing for the future and saving for retirement. Investors that are able to build wealth beyond just saving for a child’s education or retirement often make large purchases (such as cars, vacation homes, etc.) or travel more extensively. Due to the higher income of individuals in the career development stage, retirement saving tends to increase. The biggest risks for this type of investor includes: the risk of potential loss in earnings from unemployment (earnings risk), the risk of earnings loss and other costs in the case of unexpected health issues or disability (disability and health risk), risks associated with investments (asset risk), and the potential risk of liabilities from injury or damage to others, for instance from a car accident (liability risk). In addition to the risk of premature death of a partner or family member (premature death risk), there is the additional risk of retirement savings being spent too early (longevity risk). Below – we summarize the ways investors in the career development stage can protect themselves against each kind of risk.
Peak Accumulation Stage
Most individuals have reached the peak accumulation stage by age 50. Individuals in this phase are moving toward their maximum earnings and have the greatest opportunity to accumulate wealth. Objectives of individuals and families in this stage may include financial security, paying down a mortgage, providing for a comfortable retirement, and providing support to children. Some of the biggest risk exposures in this stage include the risk of worsening health (disability and health risk), premature death of a partner or family member (premature death risk), risk of outliving retirement savings (longevity risk), risk to financial and non-financial assets (asset risk), and the potential risk of liabilities from injury or damage to others, for instance from a car accident (liability risk). Investors who are using a life-cycle portfolio strategy will begin to reduce risk and prioritize income production. Additionally, investors may be more concerned about tax management, given higher levels of wealth and income. Earning risk in this phase may be higher because someone loses their job, it may be hard to find another with a similar level of pay. Below – we summarize the ways investors in the peak accumulation stage can protect themselves against each kind of risk.
Retirement Stage
For the sake of simplicity, we are grouping pre-retirement (the few years leading up to retirement where investors are focused on the tax implications of retirement plan distributions), early retirement (the first 10 years of retirement where successful investors have sufficient assets to meet expenses), and late retirement (the tail end of retirement). Primary goals for retirees in early retirement may include using their money to sustain their lifestyle, enjoy free time, continue to support family members, and potentially leave an inheritance. It is important to note that even after you have retired, the need for investments to keep growing does not end. By late retirement, assets need to cover medical expenses and health services expenses in the case of physical or cognitive decline. The biggest risks during retirement include medical costs (disability and health risk), the risk of outliving your savings (longevity risk), and potential risks to assets and liabilities as described above. In retirement, there is no earnings risk or premature death risk.
Financial priorities and goals will change as individuals progress within their careers but understanding the different types of risks and degrees of risks will help with an investor’s allocation strategy. While risks will change throughout one lifecycle so is the amount of income that an individual is able to invest. Next, we will discuss the various ways an individual can invest based on the amount of investable income they are generating.
Life Cycle Broken Down by Affluence
Average Investors
Just because an individual may not have access to a wealth manager doesn’t mean that there aren’t ways to invest. Individuals can invest through their employer if their employer offers a 401K plan, employee stock purchase plan (ESPP), stock grants, or employee stock options (ESOP). All of these options are defined at the end of this post. Personal investors can also invest individually in stocks, mutual funds, and ETFs through platforms like Robinhood and E*Trade. Additionally, this type of investor could be attracted to a “robo-advisor” solution, which is a private wealth management solution via a digital client interface in the place of a private wealth manager.
Mass Affluent
The category of personal investors at the high end of the mass market are called “mass affluent”. These are individuals with $100,000 to $1,000,000 of liquid assets plus an annual household income over $75,000. Like other types of individual investors, those in the mass affluent category often start by investing in the offerings of their employer (as outlined above). However, these investors often are attracted to private wealth management solutions, that involve a dedicated wealth manager that helps a client understand their investment goals and constraints. Despite having a dedicated manager, clients should know that each manager has a high number of clients and delivers their service with a high use of technology. Investment services are less-personalized and clients are charged brokerage fees based on transactions and/or based on assets under management. Portfolio offerings can include discretionary portfolios (the manager determines the holdings of the portfolio and clients pre-authorize the manager to make changes) or non-discretionary offering (each portfolio change requires client approval). Before selecting a wealth manager, it is important for investors to do their research and have a basic understanding of their goals and risk tolerance.
High-Net-Worth
High-net-worth individuals are those with over $1 million in financial assets. These investors typically leverage one or more wealth managers. Wealth managers for these investors have fewer clients and offer greater customization of investment services, with greater sophistication of products. In addition to saving for retirement, these individuals typically have other financial planning needs, such as estate planning.
Ultra-High-Net-Worth
Finally, we have ultra-high-net-worth individuals, with over $30 million in investable assets. These clients are typically multi-generational, and may be organized as family offices where a team of advisers work exclusively for a single family. These clients typically have complicated estate planning and financial governance needs and challenges. Wealth managers at this level have the fewest clients and offer highly customized services and advise on the acquisition of lifestyle assets such as art or yachts.
[1] https://www.jmhwealth.com/life-cycle-stages
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