Traditionally, we think about our adult life in two segments: retirement and everything else leading up to retirement. Seems simple, right? Finish school, go to work, grind, grind some more, save everything you can, hit 65 years old and retire in bliss. From a planning standpoint it sounds even more simple. Get an idea what you want life to look like in retirement, ie: travel, fish every day, drive a Cadillac, and have a house in Florida; then set your retirement account up and save all your extra money towards that goal. Not only can that sound like an unsatisfying way to live, but we all know life isn’t quite so simple. I challenge you to think about your life differently and your financial planning as well.
Consider simply structuring your planning in a different manner. Instead of two buckets (right now and retirement), I like to add one more bucket and structure them by time horizon. Time horizon being how long do you have to accomplish the goal.
Bucket one can be easy. What do you want to accomplish in the next year to eighteen months? Is it a change of job, taking a big vacation, or simply paying off some debt? This is also the timeframe you’re your emergency fund falls in. What will that take in real numbers? Once you have that sorted out, we can now start to think about where you are putting money to accomplish that. It could simply be your checking account, or you may want to start some short term investing.
What does life look like in 18months to five years? Are kids on your horizon? Buying your next home? Paying off student loans? Whatever that might be, this is still a realistic timeframe to think about and set some achievable, quantifiable goals. Instead of trying to accomplish these by stashing away cash in your bank account or under your mattress, you have some real time to invest those dollars. You always hear people say, put your money to work, investing those dollars is what they mean. Time will allow you the opportunity to earn more than your bank checking account can offer you. Consider how a brokerage account can fit here.
Imagine what you would like to do beyond five years. This gets a little more difficult by nature. We don’t know what life is going to look like, but you might have a dream you want to shoot for. Those ideas about starting your business from a passion fall in this category. It could be buying investment property. Paying for your kids’ education. Finally, yes, retirement also falls in this category. I don’t expect you to have the exact picture of what the rest of your life will look like, but the third bucket is about those dreams and passions. In this bucket is combination of brokerage accounts and retirement accounts. You have a much longer time horizon to accomplish these goals, which will allow you more opportunities to invest those dollars and take a few more risks.
You saw it in the last paragraph, risk. What does that mean? It’s different for everyone, but generally I’m referring to your ability to handle market declines. Everyone’s tolerance is different based on your personal feelings and time horizon. It’s important to talk about risk when picking your investments. Make sure your investments align with your risk tolerance, meaning don’t buy all stocks if you are completely uncomfortable seeing day to day swings in value. You also need to align risk with your buckets. Money you need in bucket one should be in a safer place, while money in bucket three can be riskier because you have time to recover from downturns. Now, these strategies are different for those early in life than they are for those closer to retirement.
To wrap, life isn’t as simple as retirement and everything before, so why should your financial plan be. What I’ve discussed is very high level and just one idea on how to shape a plan. To figure out what will work best for you and how to pick the right investments, I always encourage talking with a professional.