We are all aware that life has different phases – and that there are many ways to define these phases. The one referring to Santa Claus is probably one of the funniest, but it might not be very useful when we think about the best strategy for investing our money.
In personal finance, it is more useful to define each life phase by the difference between our revenues and our expenses.
When making an investment decision, many people only consider their current financial situation. This is not enough, because both the money we earn, our revenues, and the money we spend, our expenditures, vary throughout our life. Since our decisions not only impact our financial situation today but have also consequences for many years to come, it is necessary to foresee the main phases of our life and to understand how each of them will impact our future financial situation. This is financial planning.
In an ideal situation, revenues should be high enough to cover our living costs and to put some money aside for a rainy day. But this is not always possible.
There are phases in our life, where our expenditures tend to be higher than our revenues. This is normally the case for students, who have to rely on pocket money from their parents, occasional allowances by aunts or grand-parents or on earnings from holiday jobs. It is also typically the case for parents paying for their children’s higher education, or for retired people, who may need to draw on previous savings or capital, or even borrow money.
Middle-aged people in the prime of their earning potential, however, often earn more money than they need to cover their living costs. That’s the phase when they can allow themselves a more comfortable lifestyle, while putting some money aside. That’s also the phase when they can afford to invest and to take some financial risks.
Balancing income and expenditure: that’s what it’s all about
And finally, there are also phases where the amount of money coming in is about equal to the amount we are spending. For example this can be the case of young families.
Our life phases are determined by many elements that have an impact on our revenues and expenditure: our family situation, our professional evolution, our lifestyle and also our liabilities like borrowing for a mortgage, as well as the help we may receive from the state (such as student grants, retirement pensions or family allowances). Other factors like personal taxes, the level of interest rates and, in general, the economic environment also influence our future revenues.
Usually it is possible to plan when to move from a life phase to another one. However sudden changes of fortune – an accident, illness, the loss of a job… – can also happen suddenly and considerably change our personal situation. That’s why we should always build into our planning some buffer for periods where our spending could be higher – or our income lower – than expected.
Understanding which phase of life we are in, estimating our future financial needs, saving and spending our money wisely while putting some money aside for rainy days – that’s what financial planning is all about.
A financial adviser can help you to establish the investment strategy that is best adapted to your situation at each phase of life.
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