Tuesday, October 30, 2007
Financial Life Cycle
Your financial needs will change over time. To plan successfully, you need to consider your future in some detail. By identifying what you are likely to need at different times in your life, you can prepare an effective plan to help you achieve your financial goals.
Four Stages of Financial Life
Although everyone is different, most people go through broadly four predictable stages of development in their adult lives:
20s - Just starting out
30s - Building a family
40-50s - Career peak
60s & beyond - Retirement
Your spending and needs are likely to vary dramatically at the different life stages. Therefore, it is worthwhile to examine these stages more closely so that you can plan more effectively.
20s – Just starting out
People in their 20s have just graduated and starting their careers. You are usually earning less than you will later on. You may still be living at home with your parents. Given your new found independence, you have a big appetite for life and right now, saving might seem less important than spending. You may want to have a car, travel, party, buy fashionable clothes and so on. Many people at this stage tend to spend too easily and there is a danger of getting into debt by over-using credit cards and taking loans.
Most people in their 20s have yet to insure themselves. You might not need much life insurance if you are not married or if your parents or siblings are not financially dependent on you. However, you should have some health, critical illness and disability coverage as illnesses and accidents can happen at any point of your life. For those who are in good health and are still young, the premiums will be relatively inexpensive.
The priority of those in their 20s will be to build up their emergency funds if they do not already have sufficient savings. You are likely to set aside a bigger part of your savings for more short term needs such as marriage or buying a home. However, you should not neglect saving and investing for the long-term as the effect of compounding works best the earlier you start.
Start by investing whatever excess you have after setting aside enough for your daily expenses and short term needs. It does not matter if you only have a very small amount to begin with but it is important to take that first step to start planning for your future.
30s – Building a family
If you haven’t already done so in your 20s, the 30s will be the time to lay the foundations for future wealth. You will probably be earning more as you have progressed in your career.
For those who are married and are starting a family, your expenditures would have in-creased dramatically as you may be paying for your home mortgage, car loan and planning for your children’s education.
At this stage of life, many of you will not only be caring for your young children but are also supporting elderly parents. For those with dependants, you will most certainly need more life insurance in the event of unforeseen circumstances such as death, disability or critical illness. Health and disability insurance are also necessary to help pay for medical expenses and provide income in the event of disabilities. Those with mort-gage loans should purchase mortgage insurance so that the burden of servicing the loans will not fall on your loved ones in the event of death or disability.
It is also recommended to make a will to state how your wealth should be distributed after your death and by whom. For those with children, you may need to nominate a suitable person to look after your children in the event both you and your spouse pass on together.
A larger amount of emergency fund may be needed due to the increased monthly financial commitments. It is recommend-ed to keep at least 6 months of income in the emergency fund (subject to individual circum-stances). If there are children, you will need to be saving for the children’s higher education. You can choose to save via endow-ment policies, investment-linked policies, regular investment plans or purchase bonds – all of which should produce a higher return than a bank deposit over a long period.
At this stage, you should already have began saving for your retirement. The earlier you start, the more time your money will be allowed to grow and the bigger retirement nest egg you will be able to build. Although you may be contributing to CPF which would also provide for your retirement, your CPF funds alone might not be sufficient given inflation and longer lifespan. You can choose to save for retirement through cash-value insurance, endowment plans, bonds, diversified mutual funds or stocks etc. You may also consider contributing to the Supplementary Retirement Scheme which provides special tax incentive.
40-50s – Career Peak
Middle age is the time when most people are at the peak of their careers and earning power. That’s also the time when you have more experience and the money to take a more active approach to investment. Since retirement age is approaching, now is the time to transform as much as your earnings into investment capital as possible.
If you have children, they may be in higher education by now or have already started work. If money has already been set aside for the children’s education in the past, education expenditures will no longer be coming from your income. As earnings may have increased more than expenditures, you are likely to have more money to save and invest than ever before.
Life and health insurance premiums will become more expensive because you are older. Now is the time to look into protection for long-term care in the event of disability. One such plan is the ElderShield plan. It is important to periodically update your will should your circum-stances change.
At this stage, your savings and investments portfolios are likely to be larger than before. For those who have the knowledge and experience, you may want to hold more equities and other more sophisticated and volatile investments. For those who have a low appetite for risk, you can focus more on bonds within your investment portfolio.
60s and Beyond - Retirement
Some people will continue to work and earn a high salary in their old age but many would have given up working at this point. As a retiree (or semi-retiree), your income may be lower or zero and your expenditure is likely to be lower too. If your income from pensions and support from family members are sufficient to meet your monthly expenses, you will be able to continue to work on capital growth. But for most people, they are likely to start withdrawing money from their savings and investments to pay for their monthly expenses. Once you start withdrawing money for income, your invest-ment capital will grow more slowly or even shrink over time.
Most of your big financial commitments such as paying for your home and supporting children will be over. Daily expenses are likely to drop but recreational and healthcare expenses are likely to increase. Health insurance premiums will increase dramatically as you age and you may need to draw on your savings or investments to avoid letting your coverage lapse at this point when you need it the most. You will need to constantly review your will as your family’s circumstances or tax laws may change. It is also important to look into estate planning to avoid hefty estate taxes which might burden your dependants or serve to reduce the amount of inheritance that you hope to pass down.
If you are still drawing an income from work, you can still continue to save. But for most, the challenge is to withdraw sufficient savings and investment income to live while preserving the value of their portfolio. There are many investment schemes that allow you to draw down income when you wish but you need to examine their individual pros and cons very carefully.
At this stage, protecting your capital is important. Do not take needless risks just so to try to increase your investment income. And because you have less time left to ride out the volatility in equity markets, it is probably wiser to reduce risks to the minimum and focus on capital protection instead. You may want to invest in less risky instruments such as bonds, Treasury bills, fixed deposits or certain structured products. Although some of these investments may still carry a risk of capital loss, the risks tend to be limited while offering the potential for a higher regular income than cash deposits. Some people may make the mistake of being too overly cautious by placing all their money in cash deposits which yield very minimal interests. If in a climate of high inflation, their retirement plan might be seriously compromised as the return from their savings deposits may not even match up with the inflation rate. There are also other alternative methods to generate income, such as through renting, downgrading of home or reverse mortgage.
Conclusion
This ‘life stage’ approach to financial planning is useful because when you are able to foresee what generally is to come, you will be able to plan more effectively than if you were to adopt a ‘fire in the dark’ method. And because your financial needs change over the various life stages, it is very important to review your financial portfolio with your adviser on a regular basis to ensure that the financial strategies laid out previously are still in line with your needs at any particular stage of your life.
Four Stages of Financial Life
Although everyone is different, most people go through broadly four predictable stages of development in their adult lives:
20s - Just starting out
30s - Building a family
40-50s - Career peak
60s & beyond - Retirement
Your spending and needs are likely to vary dramatically at the different life stages. Therefore, it is worthwhile to examine these stages more closely so that you can plan more effectively.
20s – Just starting out
People in their 20s have just graduated and starting their careers. You are usually earning less than you will later on. You may still be living at home with your parents. Given your new found independence, you have a big appetite for life and right now, saving might seem less important than spending. You may want to have a car, travel, party, buy fashionable clothes and so on. Many people at this stage tend to spend too easily and there is a danger of getting into debt by over-using credit cards and taking loans.
Most people in their 20s have yet to insure themselves. You might not need much life insurance if you are not married or if your parents or siblings are not financially dependent on you. However, you should have some health, critical illness and disability coverage as illnesses and accidents can happen at any point of your life. For those who are in good health and are still young, the premiums will be relatively inexpensive.
The priority of those in their 20s will be to build up their emergency funds if they do not already have sufficient savings. You are likely to set aside a bigger part of your savings for more short term needs such as marriage or buying a home. However, you should not neglect saving and investing for the long-term as the effect of compounding works best the earlier you start.
Start by investing whatever excess you have after setting aside enough for your daily expenses and short term needs. It does not matter if you only have a very small amount to begin with but it is important to take that first step to start planning for your future.
30s – Building a family
If you haven’t already done so in your 20s, the 30s will be the time to lay the foundations for future wealth. You will probably be earning more as you have progressed in your career.
For those who are married and are starting a family, your expenditures would have in-creased dramatically as you may be paying for your home mortgage, car loan and planning for your children’s education.
At this stage of life, many of you will not only be caring for your young children but are also supporting elderly parents. For those with dependants, you will most certainly need more life insurance in the event of unforeseen circumstances such as death, disability or critical illness. Health and disability insurance are also necessary to help pay for medical expenses and provide income in the event of disabilities. Those with mort-gage loans should purchase mortgage insurance so that the burden of servicing the loans will not fall on your loved ones in the event of death or disability.
It is also recommended to make a will to state how your wealth should be distributed after your death and by whom. For those with children, you may need to nominate a suitable person to look after your children in the event both you and your spouse pass on together.
A larger amount of emergency fund may be needed due to the increased monthly financial commitments. It is recommend-ed to keep at least 6 months of income in the emergency fund (subject to individual circum-stances). If there are children, you will need to be saving for the children’s higher education. You can choose to save via endow-ment policies, investment-linked policies, regular investment plans or purchase bonds – all of which should produce a higher return than a bank deposit over a long period.
At this stage, you should already have began saving for your retirement. The earlier you start, the more time your money will be allowed to grow and the bigger retirement nest egg you will be able to build. Although you may be contributing to CPF which would also provide for your retirement, your CPF funds alone might not be sufficient given inflation and longer lifespan. You can choose to save for retirement through cash-value insurance, endowment plans, bonds, diversified mutual funds or stocks etc. You may also consider contributing to the Supplementary Retirement Scheme which provides special tax incentive.
40-50s – Career Peak
Middle age is the time when most people are at the peak of their careers and earning power. That’s also the time when you have more experience and the money to take a more active approach to investment. Since retirement age is approaching, now is the time to transform as much as your earnings into investment capital as possible.
If you have children, they may be in higher education by now or have already started work. If money has already been set aside for the children’s education in the past, education expenditures will no longer be coming from your income. As earnings may have increased more than expenditures, you are likely to have more money to save and invest than ever before.
Life and health insurance premiums will become more expensive because you are older. Now is the time to look into protection for long-term care in the event of disability. One such plan is the ElderShield plan. It is important to periodically update your will should your circum-stances change.
At this stage, your savings and investments portfolios are likely to be larger than before. For those who have the knowledge and experience, you may want to hold more equities and other more sophisticated and volatile investments. For those who have a low appetite for risk, you can focus more on bonds within your investment portfolio.
60s and Beyond - Retirement
Some people will continue to work and earn a high salary in their old age but many would have given up working at this point. As a retiree (or semi-retiree), your income may be lower or zero and your expenditure is likely to be lower too. If your income from pensions and support from family members are sufficient to meet your monthly expenses, you will be able to continue to work on capital growth. But for most people, they are likely to start withdrawing money from their savings and investments to pay for their monthly expenses. Once you start withdrawing money for income, your invest-ment capital will grow more slowly or even shrink over time.
Most of your big financial commitments such as paying for your home and supporting children will be over. Daily expenses are likely to drop but recreational and healthcare expenses are likely to increase. Health insurance premiums will increase dramatically as you age and you may need to draw on your savings or investments to avoid letting your coverage lapse at this point when you need it the most. You will need to constantly review your will as your family’s circumstances or tax laws may change. It is also important to look into estate planning to avoid hefty estate taxes which might burden your dependants or serve to reduce the amount of inheritance that you hope to pass down.
If you are still drawing an income from work, you can still continue to save. But for most, the challenge is to withdraw sufficient savings and investment income to live while preserving the value of their portfolio. There are many investment schemes that allow you to draw down income when you wish but you need to examine their individual pros and cons very carefully.
At this stage, protecting your capital is important. Do not take needless risks just so to try to increase your investment income. And because you have less time left to ride out the volatility in equity markets, it is probably wiser to reduce risks to the minimum and focus on capital protection instead. You may want to invest in less risky instruments such as bonds, Treasury bills, fixed deposits or certain structured products. Although some of these investments may still carry a risk of capital loss, the risks tend to be limited while offering the potential for a higher regular income than cash deposits. Some people may make the mistake of being too overly cautious by placing all their money in cash deposits which yield very minimal interests. If in a climate of high inflation, their retirement plan might be seriously compromised as the return from their savings deposits may not even match up with the inflation rate. There are also other alternative methods to generate income, such as through renting, downgrading of home or reverse mortgage.
Conclusion
This ‘life stage’ approach to financial planning is useful because when you are able to foresee what generally is to come, you will be able to plan more effectively than if you were to adopt a ‘fire in the dark’ method. And because your financial needs change over the various life stages, it is very important to review your financial portfolio with your adviser on a regular basis to ensure that the financial strategies laid out previously are still in line with your needs at any particular stage of your life.
