Investment Portfolio Phase & Stage of Life

Posted By: Advisor Analyzer Team

As the old Byrd’s song goes, “A time to be born, a time to die, A time to plant, a time to reap, A time to kill, a time to heal, A time to laugh, a time to weep.” Those words have never rung more true in to the modern day investor. Everyone goes through different stages of life, from childhood, to youth, to adulthood, maturity, retirement and death.

 

When it comes to financial planning, the stage of life for an investor can provide tremendous insight into the client’s ability and willingness to take investment risk. Generally, the ability to take risk should gradually decline as the investor progresses through each life cycle. However, the willingness of the investor is often driven by their overall income and expenses. In general, there are four phases of that are most applicable for today’s investor: foundation, accumulation, maintenance and distribution.

Foundation Phase

The foundation phase is the base upon which the client will establish wealth creation. This is a time the individual sharpens their marketable skills, starts a business, expands upon their education or obtains certifications and designations for their future careers. Often, the investors are young, with a long time horizon, which can allow for above average risk tolerance.

 

However as we all know, life is not without irony, and this stage is often when an individual’s investible assets are lowest and financial uncertainty is highest. While the future earnings potential for the investor may be high, potential future expenses will usually grow in tandem with income. Individuals will experience more financial responsibilities with marriage, kids, etc… that may prohibit the ability to expand one’s wealth accumulation.

Accumulation Phase

As the individual graduates from the foundation phase, they will undoubtedly begin to reap the rewards of their efforts. During the accumulation phase, the investor’s earnings will increase the most, and the returns from both their foundation phase and investments will also grow significantly.

 

In the earlier part of the accumulation phase, expenses will continue to rise as home purchases, and kid’s education tuition costs begin to accrue. In the later portions of the accumulation phase, these expenses will begin to decline, as the individual’s mortgages are paid in full and their children finish schooling and become financially independent.

 

Given the investor doesn’t change their spending habits with frivolous purchases, the gap between income and expenses should widen, thereby allowing for more pronounced wealth accumulation. Usually, the accumulation phase allows for higher levels of risk tolerance given increasing wealth and relatively long investment horizon.

Maintenance Phase

The maintenance phase is characterized by an individual’s desire to maintain their current living conditions. Usually, the investor is retired and will have a substantial portion of their required expenses met through their investment portfolio. They are no longer able to rely on earned income to meet daily living expenses so the portfolio’s objective and holdings will often focus on preservation of wealth and financial security.

 

The investor’s risk tolerance will begin to decline, and the focus of the portfolio will shift from growth to price stability. The investor’s portfolio will be a major source of cash flows during this phase, and the portfolio allocation continues to tilt towards less volatile and income producing securities. The main challenge for the investor in this phase will focus on maintaining purchasing power and outperforming inflation.

Distribution Phase

For those who are fortunate enough to eliminate the possibility of portfolio attrition, the portfolio’s role will continue to evolve. The focus here is to transfer the individual’s assets in the most tax efficient manner possible. The portfolio will still play a pivotal role to meet the investor’s ongoing needs, but the individual will be more concerned with maximizing the after tax transfer of assets to one’s heirs and beneficiaries. Often, estate planning, creating trusts and foundations dominate the activities during this phase. The investments will begin to be managed for the new objectives of the beneficiary, which may consist of a completely different asset allocation.

Conclusion

While we all may want to “live forever young”, the unfortunate reality is the time we have here is all too temporary. Investors will inevitably progress from one stage of life to next, and their portfolios’ will concurrently experience similar transitions between phases. While there is little we can do to stop mortality, it is important for investors to recognize their stage of life and investment phase, as a guide to determine the asset allocation and acceptable level of risk for one’s portfolio.