Personal Finance: Investment Life Cycle

Today I bring you a “catch-post”  on one of the most important topics in personal finance and investment throughout our lives; the investment life cycle. At different age ranges, we will have different needs, incomes, savings capacity, and, ultimately, different flows of money that come and go.

Many people ask me, where do I put my money? And it all depends a lot on the age you are in your work situation, etc. The vital period in which you find yourself, as long as it has passed within certain normality, is the key. There are not a few people who are close to retirement in age who ask me this choice; close relatives, friends, professional colleagues, etc. There is no universal basic rule for life, but if there are some ideal guidelines within the age ranges, hence it is called (or at least as I call it) the life cycle or life cycle of investments.

It is also very important because it incorporates long-term discipline, which is surely the most difficult to fulfill and one of the keys to success, that you accumulate capital that grows over time. Would you have the discipline to run every week of your life even if it snows, you break your leg, you get sick, you feel bad or you get old?

In the end: a financial plan throughout your life that you follow systematically and an adequate allocation. That is the whole essence. You absolutely don’t need anything else. Not even reading anything about finance in your entire life.

(Note: allocation is the distribution of different investments or types of assets. For example 20% in bonds and 80% in stocks. From now on we call it allocation).

Your allocation will change throughout your life, it will change several times. When you start working and saving, until the 30’s life is relatively simple if you have a job, but then everything gets complicated and neither changes are expected nor come when we want.

It is a path in which we first convert our work effort into assets and then, in our retirement, we move on to live on those (financial) assets.

Different ages carry different needs and obligations that carry different perceptions of investment risk.

No one can foresee what will happen in the future, tomorrow, neither in our lives nor in the financial markets. For this reason, this is not going to be right or wrong, that possibility does not exist, what is possible is to have a plan whose long-term mathematical hope is positive and, no matter what happens tomorrow, it behaves in this way. 

What helps us to overcome this is a correct asset allocation or configuration of our investments. A correct selection of assets —allocation— is one that allows us to have a high probability of achieving our financial objectives – positive mathematical hope – compatible with our emotional reactions to bad times and streaks.

In general, we have the same financial goals and concerns; financial security and not running out of money in an uncertain future.

The investment life cycle is divided into four stages. We are going to see each of these four stages and how you should organize yourself in each one from now on.

 

1. Young Saver – Early Saver –

It is the person who is between 20 and 39 years old.

Start saving in your first years of work and get into the habit of saving more or less systematically. Controlling risk and selecting your investments is important, but most important at this stage is developing the habit of saving, because saving on a regular basis will grow your future wealth faster than anything else. The biggest failure of a person at this age is not learning to save, and this is something that goes against the modern mentality of consumption.

A 10% savings rate can be a good start. The ideal according to several studies is 20% in general, but if we follow the stages differently in this first young saver or early saver, 10% is enough.

In this first stage, the majority are already lost, since buying a house that requires more than 40% of salary and the uncertainty of changing jobs several times make the discipline of saving dilute.

Start saving now systematically, remember the difference between starting to save a little now or doing it later.

The great advantage of the young saver is that he has abundant human capital and time. If the investments go wrong, you have the opportunity to continue buying cheaper and in time you will recover and win. You have at least 4 decades to see how it is corrected.

You should have about 6 months of expenses in a deposit account or equivalent cash for any emergency or unforeseen.

It is the stage in which you can be more aggressive in your investments:

• Risky: 80% equity + 20% fixed income
• Moderate: 70% variable income + 30% fixed income
• Conservative: 60% variable income + 40% fixed income

 

2. Mature Saver – Midlife Accumulator –

For a person who is between 40 and 59 years old.

It has stabilized in all the orders of its material and family life and is a net accumulator thanks to that stability; income, house, car, etc. They know where they are and where their life is going.

In the same way that a person at that age has matured physically and psychologically, he has also matured financially. She begins to face half of life and knows that the years of work have an end with all that that entails. This has an effect on how you save and invest. The time horizon is different and the expectations and needs are taking another form.

A mature saver has experienced one or two economic recessions, has seen financial markets collapse and interest rates have danced from top to bottom, and has probably had to lose his job and reinvent or re-adapt to new realities.

This makes you see your investment allocation with different eyes since you know much better the dangers of investing. The concept of risk is quite different.

This is the stage when you consider that you will need for retirement and how much you will need to live. His calculations and vision are more realistic. For this reason, it is a stage that fundamentally accumulates savings, it is the stage that your income is most stable and high. Hence its name in English, “midlife accumulator” is literally something like “accumulator (capital) in the middle of life.”

The mature saver or “midlife accumulator” realizes three fundamental things:

1. Your productive years of recurring income come to an end
2. You need a systematic investment plan that ensures your retirement years
3. The speculative experiments of his younger stage are over. You need security and certainty.

 

Table of assets and liabilities: (asset-liability matching)

The asset-liability matching or “income and expenses table ” or ” obligations and rights table ” is the investment method that allows balancing future cash flows. Future expenses will generate outflows and assets will generate inflows: expenses and income must be balanced, or liabilities and assets. For this, you must choose what investment allocation and pace of life can take.

Steps of the block plan:

1. Estimate future living expenses per year
2. Estimate sources of income that do not come from investments (retirement, social security)
3. Compare 1. and 2., and see the negative gap between the two
4. Calculate what is the allocation you have to have to square that imbalance
5. Systematically carry out the investment plan that is suitable for 4. with the highest probability of profit and the least risk according to the circumstances.

You should have about 12 months of expenses in a deposit account or equivalent cash for any emergency or unforeseen.

Speculative investments have to start to decrease.

The fiscal impact is a very important issue since in the long term it can erode your investments significantly. It is recommended that you be advised by a good prosecutor if you have already accumulated good capital, which will save you a lot of money.

In this stage of investment there is still a significant part of variable income (more risk) but in a lower percentage than in the young saver:

• Risky: 70% equity + 30% fixed income
• Moderate: 60% variable income + 40% fixed income
• Conservative: 50% variable income + 50% fixed income

 

3. Early Retiree and Active Retiree – Transitional Retire –

For a person who is between 60 and 79 years old.

It covers a very diverse stage; from the years before retirement in which he still works to the years of active life as a retiree, those in which he enjoys his well-deserved rest.

This stage begins in the 2 or 3 years prior to retirement or retirement from work. They generally coincide with the highest and most stable salary in a professional career. Household expenses are stabilized, children are self-sufficient or are beginning to be self-sufficient, and the savings rate is the highest.

Moving from this sequence to retirement is a momentous step. Less will be entered, there will be less autonomy.

All this marks the investment allocation; above all the accumulated savings throughout life have to be safe. Safety is the most important thing; not lose before win.

Aware of the need to manage this accumulated capital or patrimony in the most optimal way, it is the stage where the early retiree and then active retiree is more conservative.

You should have at least 2 years of expenses in a deposit or cash equivalent account for any emergency or unforeseen.

And speculative investments have disappeared or should be. If they go wrong there is not much time to get it back. It is also a distribution stage, you begin to distribute savings, not accumulate it.

Here the transcendental question is always the same, how much do I withdraw from my investments? How much am I distributing or consuming?

 

Retirement investment withdrawal rate

There are several studies with highly developed and robust research and data, and all reach the same consensus: the withdrawal rate should be around 4% of the accumulated investment.

However, this 4% withdrawal must be subject and qualified by three fundamental aspects:

1. At what age do you retire/retire?
2. How long do you plan to live?
3. How long do you think you will be living actively?

This configures the time and level of expenses, which tells us the percentage of withdrawal that we can make according to the accumulated capital.

At this stage of investment, the portfolio still needs to continue growing, especially for the first years of its most active life and with the most expenses. The investment portfolio would be as follows:

• Risky: 60% equity + 40% fixed income
• Moderate: 50% variable income + 50% fixed income
• Conservative: 30% variable income + 70% fixed income

 

4. Mature Retiree – Mature Retire –

A person who is over 79 years old.

Quiet and passive life. The rhythm of life and spending is determined by the state of health. The expense is less.

Pure distribution stage. You have to live on the income generated.

You should have at least 2 years of expenses in a deposit or cash equivalent account for any emergency or unforeseen.

At the end of this stage, you must have prepared how you want the accumulated capital and assets that you leave the day you die to continue so that the children continue to enjoy the security and certainty that it has provided to them. The ideal is to have everything well-identified and written, if possible not very dispersed among managers and depositaries of quality and proven security.

As you can see, allocation changes little by little throughout life. this is not in contradiction with the permanent portfolios that we are learning. Although what should be pointed out that these permanent portfolios are adequate whenever you start to implement them at your stage young or mature saver.

Later it is advisable to follow what is stated in this article, with a part in fixed income and cash well identified since there are not so many years to recover the bad years. The rebalancing with constant contributions, and the trend to the average that follows this system.

You can also adapt the permanent portfolio to the ideal% of your life cycle, it would be a safer, more conservative system; it’s actually totally complimentary. Here you see what cash you need in the form of a security deposit for contingencies, what part you can allocate to speculative investments and the rest of the allocation to the permanent portfolio you have chosen. The important thing once again is to know the framework in which you move and the long-term strategy, respecting the safety margins.