EACH life is different. Nonetheless, most of us consume and generate wealth in a predictable, understandable fashion.
When we are young and not earning money, we consume more than we produce.
Then, hopefully during our working years we produce (earn) more than we consume, which permits us to save and invest for tomorrow.
Finally, as we age and morph from vigour to decrepitude we draw down our savings (and investments) to fund our final years.
This pattern is of such fundamental importance that the late economist Franco Modigliani won the 1985 Nobel Prize in Economics for recognising it!
His famous Life Cycle Hypothesis postulates that we defer consumption during our younger years to pay for future consumption in our older decades, which leads us to do three things:
WE tend to consume wealth at a steady rate throughout our lives;
WE, therefore, gradually accumulate a stock of wealth during our working years; and,
WE consume that stock of wealth during our subsequent non-working retirement years.
Here’s a chart illustrating how we consume, earn and save over time, which is predicted by Modigliani’s hypothesis.
To learn about his work, visit www.nobelprize.org/nobel_prizes/economics/laureates/1985/press.html.
Understanding the crux of Modigliani’s hypothesis will help you to figure out where on his curve you are today and how you might best manage the rest of your life.
Work by American financial planner Eleanor Blayney, consumer advocate of the Certified Financial Planner Board, involves five stages of life that fit the hypothesis:
Stage 1 – The starting out years
Age range: 18-25 — These are critical years; your choices on education, employment and debt management will have a major impact on your financial situation for decades.
Stage 2 – The nesting years
Age range: 25-40 — During this phase, you face important decisions about marriage, children, buying a home and building a career. Understanding the financial implications of these decisions is critical to lifetime success.
Stage 3 – The prime time years
Age range: 40-55 — This is usually the time when you have more discretionary income.
But there may be a lot of demands on that income, so advice is needed about college tuition, helping elderly parents and catching up on retirement savings.
Stage 4 – The wealth accumulation years
Age range: 55-65 — Retirement is coming into view. Will it be a time of reinvention or scraping by? Personal lifestyle, spending and investing choices will make all the difference.
Stage 5 – The reinvention years
(Age range: 65 and over — These can be the best years of life with new interests, part-time work or volunteer activity, travel and more time with family and friends if financial resources are managed well.
As our lifespans lengthen, our working lives will exceed the norm of 30 years and grow to four or five decades! However, the dramatic rise of healthcare costs, particularly in geriatrics, means it will become more important to minimise debt accumulation during our youth, and increase savings and investments during our working years.
So, the best way to prepare for an extended golden retirement is to prepare to work longer than those who do not understand the crucial need to maximise active income generation by focusing on raising personal value in the workplace.
You need to work longer because you are likely to live longer. Therefore, reengineer yourself into an indispensable knowledge worker through diligence and study.
Twitter@RajenDevadason
The writer is a Securities Commission-licensed financial planner, professional speaker and author. Read his free articles at www.FreeCoolArticles.com and connect via LinkedIn at https://www.linkedin.com/in/rajendevadason