Assuming the basis insurance and cash reserve needs are met, individuals can start a serious investment program with their savings. Because of changes in their net worth and risk tolerance, individuals’ investment strategy will change over their lifetime.
In the following section, we review various phases in the investment life cycle. Although each individual’s needs and preferences are different, some general traits affect most investors over the life cycle. The four life cycle phases in investment program are
1. Accumulation phase
2. Consolidation phase
3. Spending phase
4. Gifting phase
Accumulation phase
Individuals in the early-to-middle years of their working careers are in the accumulation phase. As the name implies, these individuals are attempting to accumulate assets to satisfy fairly immediate needs (for example, a down payment for a house) or longer-term goals (children’s college education and retirement fund).
Typically, their net worth is small, and debt from car loans or housing loan may be heavy as compare to individual income.
As a result of their typically long investment horizon and their future earning ability, individuals in the accumulation phase are willing to make relatively high-risk investments in the hope of making above-average nominal returns over time.
Here we must emphasize the wisdom of investing early and regularly in one’s life. Funds invested in early life-cycle phases, with return compounding over time, will reap financial benefits during later phases.
Consolidation phase
Individuals in the consolidation phase are typically past the midpoint of their careers, have paid off much or all of their outstanding debts , and perhaps have paid , or have the assets to pay , their children’s college bills.
Earning exceeds expenses, so the excess can be invested to provide for future retirement or estate planning needs. The typical investment horizon for this phase is still long (20 to 30 years), so moderately high risk investments are attractive. At the same time, because individuals in this phase are concerned about capital preservation, they do not want to take very large risks that may put their current nest of egg in jeopardy.
Spending Phase
The spending phase typically begins when individuals retire. Living expenses are covered by social security income and income from prior investments.
Because their earning years have concluded (although some retirees take part-time position or do consulting work), they seek greater protection of their capital. At the same time, they must balance their desire to preserve the nominal value of their savings with the need to protect themselves against a decline in the real value of their savings due to inflation.
As an average individual after retirement has a life expectancy of 20 - 30 years ,thus, although their overall portfolio may be less risky than in consolidation phase, they still need some risky growth investments, such as common stocks, for inflation (purchasing power) protection.
The transition into the spending phase requires a sometimes difficult change in mindset; throughout our working life, we are trying to save; suddenly we can spend.
We tend to think that if we spend less, say 4 percent of our accumulated funds annually instead of 5, 6 or 7 percent; our wealth will last far longer. But a bear market early in our retirement can greatly reduce our accumulated funds. Fortunately , there are planning tools that can give a realistic view of what can happen to our retirement funds should markets fall early in our retirement years; this insight can assist in budgeting and planning to minimize the chance of spending ( or losing ) all the saved retirement funds.
Annuities, which transfer risk from the individual to the annuity firm (most likely an insurance company), are another possibility. With an annuity, the recipient receives a guaranteed, life long stream of income.
Gifting phase
The gifting phase is similar to, and may be concurrent with, the spending phase. In this stage, individuals believe they have sufficient income and assets to cover their current and future expenses while maintaining a reserve for uncertainties. Excess assets can be used to provide financial assistance to relatives or friends and to establish charitable trusts.
Life cycle Investment Goals
During the investment life cycle, individual have a variety of financial goals. Near term, high priority goals are shorter-term financial objectives that individuals set to fund purchases that are personally important to them, such as accumulating funds to make a house down payment, buy a new car or take a trip. Parents with teenage children may have a near term, high priority goal to accumulate funds to help pay college expenses. Because of the emotional importance of these goals and their short time horizon, high risk investments are not usually considered suitable for achieving them.
Long term, high-priority goals typically include some form of financial independence, such as the ability to retire at a certain age. Because of their long-term nature, higher-risk investment can be used to help meet these objectives.
Lower-priority goals are just that – it might be nice to meet these objectives, but it is not critical. Examples include the ability to purchase new car every few years, redecorate the home with expensive furnishings, or take a long, luxurious vacation. A well-developed policy statement considers these diverse goals over an investor’s lifetime.
