Financial planning for someone who is 22 is fairly easy. It is a bit like planning for a job loss you know you’ll have five years in the future. There is plenty of time to check into different options, learn new skills, and make mistakes along the way. You can also take calculated risks because you have something to fall back on – income from your job – for several years. You could try your hand at painting and selling your art or digging for gold in your spare time before you focus into more concrete pursuits, knowing that you’ll still have that steady paycheck coming in each month for a few more years.
It gets much more difficult for someone who is in their mid-to-late fifties, and even more difficult for someone who is in their sixties or even retired. By that point the die is largely cast and there is little room for mistakes. Suffer a big loss in the stock market when you are 25 while invested in mutual funds and you can usually just hold on and wait since it is very likely the fund will recover a good portion of the loss over the next several years. If you buy an individual stock that collapses and is not likely to recover in your twenties, you can cut your losses, build up some more cash, and buy into different stocks. If you suffer a similar loss when you are 60, unless you have a net worth that will generate a lot more income than you need, and you may not have the time for your account to rebuild itself before you need to sell assets for living expenses.
How you invest in your fifties and sixties is therefore highly dependent on your net worth and your income needs. Unfortunately most people still have quite a bit of debt in their fifties from home remodels, children’s weddings, children’s college, vacations, and other lifestyle choices. Others are largely debt free, except for their home, but have little saved up in retirement accounts, let alone personal investment accounts. So starting from this point, what are the priorities and what types of investments are appropriate?
1. Get out of debt. The biggest priority at this stage of life should be getting out of debt and staying there. If you have lots of money, there is no reason to keep paying out interest every month (and no, you aren’t saving it on taxes – you’re receiving maybe 30 cents on the dollar). Your financial security will increase dramatically if no one can come repossess your home or take your savings should your income stream slow or stop. Owning your home outright also opens up the possibility of selling in a high cost area and moving to a condo or a townhouse in a low-cost one, freeing up a lot of cash for living expenses. This was the typical retirement plan before the HELOC was invented.
2. Build up assets. If you don’t have a large number of assets (things like stocks and bonds that pay you income) by this point, you need to start working overtime to build you financial base. The more assets you have when you enter retirement, the more flexibility you’ll have. Because you’ll be able to take some risk with a portion of your portfolio, you’ll be able to earn more income in retirement if you have substantially more than you’ll need to generate the minimum income necessary. Have $1 million, and you might have a $40,000 per year income. Have $2 million, and you might have a $100,000 per year income because you can invest more aggressively.
3. Start safe, then get more aggressive with investments. Your ability to take risks with your money declines as you get closer to needing the money. Unfortunately, inflation is still eating away at your savings, so you can’t tuck your money in your mattress either. You’ll need to start with placing a portion of your funds in assets you have confidence will be there, such as CDs, and then broaden out to gain investment return. After securing a reasonable cash cushion (that you would grow as you get closer to retirement), you would start to branch out into large cap equity funds (or ETFs) and income funds, then move into REITs and small cap funds. Finally, if you have the resources, you can start buying individual stocks and bonds. You might also consider rental real estate, although this comes with headaches and some of the same risks of catastrophic decline that you see with individual stocks. If you have been investing all along, you would make the shift the other way, selling of some of your individual stocks and buying mutual funds and ETFs as you got older, then building up some cash as you near retirement.