Financial planning is the work of a lifetime, and the discipline of lifecycle finance takes the idea literally, using the human lifetime as an organizing principle for financial decision making. With lifecycle finance, also referred to as the lifecycle approach, a household’s financial activities are divided into a series of time periods. Each time frame encompasses a standard set of age-linked milestones which are used as the starting point for planning.
According to Dr. Wade Pfau, Professor of Retirement Income at The American College of Financial Services, the lifecycle approach offers a framework for keeping a household’s standard of living consistent over decades. “Households wish to spread their resources over their lifetime to maintain a consistent living standard. This means saving for retirement while one is working, or spending less than they earn so that they can later spend more than they earn after work stops,” Pfau explains in this article.
When using the lifecycle approach, evaluate financial decisions with the goal of creating a consistent stream of income for a lifetime. As Pfau writes: “The power of this approach is that it provides a clear framework for evaluating different decisions in terms of the impacts on the sustainable lifetime standard of living.”
Pfau explains that at each stage, planners will lead clients through an analysis comparing how the financial actions they make in the present impact their later standard of living. “Matters which can be addressed include renting vs. buying a home, whether to have another child, whether to live in an expensive city, whether to contribute to tax-deferred retirement accounts, when to retire and to claim Social Security, and even whether it is financially advantageous to cohabitate or to get married,” Pfau explains.
Learn the 5 Financial Life Stages
These are the standard financial life stages encompassed in the lifecycle approach:
1. Early Career: Ranging in age from 25 to 35 years old, early career phase clients are typically newlyweds building a foundation for a strong financial future. If they do not already have young children, they are planning to start a family. If they do not yet own a home, they are saving for one. At this stage keeping income in step with expenses is a struggle, but it’s important to lay the groundwork for retirement saving now.
2. Career Development: From ages 35 to 50, earnings rise, but so do financial demands. Keeping expenses in line with income is a challenge in this stage. Many families are concerned with covering college costs and paying for ongoing expenses while also increasing the pace of saving for retirement.
3. Peak Accumulation: In this stage, from the early 50s into the early 60s, clients typically reach their maximum income level. It may be a time of relative freedom for clients whose children have graduated from college. Without college tuition and with lower expenses thanks to their empty nests, they can accelerate savings rates to position themselves for a more secure retirement.
4. Pre-retirement: About 3 to 6 years before winding down professionally, clients start restructuring assets to reduce risk and increase income. By this point, mortgages are usually paid and children are independent. This is the time to evaluate retirement plan distribution options and tax consequences of investments.
5. Retirement: The final financial lifecycle phase occurs for clients in their mid-60s and beyond. Once clients stop working, their focus shifts from wealth accumulation to income preservation. In this stage, the goal is to help clients preserve purchasing power and enjoy their desired lifestyle. Legacy and estate planning also gains prominence as clients age.
As clients transition through each stage, the planner stays involved and adjusts the focus each step of the way to ensure the household’s plan remains appropriate for their risk tolerance, ages, and goals.
The Fine Print
When using the lifecycle approach remember — to quote the poet Robert Burns — “The best-laid plans of mice and men often go awry.”
There are no absolutes when it comes to the pace of clients’ lives unfolding. Marriages may end. Sadly, family members do become seriously ill or pass away. Jobs are lost. On the happier side, there are inheritances and promotions. In each case, it is the responsibility of the financial professional to review the ramifications of life altering events and adjust the plan appropriately. Age ranges are merely guideposts and some clients will pass through stages more quickly or slowly depending on their abilities.
Financial planning is a dynamic process that changes and evolves throughout a client’s lifetime. Professional advisors who earn the Chartered Financial Consultant® (ChFC®) designation from The American College of Financial Services receive a comprehensive education that prepares them to help investors at all life stages make smart decisions.
Read, How the ChFC® is a Game Changer in Advancing Your Financial Planning Career, and learn more about how earning a ChFC® helps planners serve investors better. You will gain insights on how to retain a loyal customer base, acquire new high-net-worth clients, increase earnings, and strengthen your reputation as a financial expert in a shortened time frame.