3 Financial Phases of Life

There are three main financial phases of life: accumulation, preservation, and distribution. Each stage has different goals, risks, and opportunities. It’s important to understand all three phases so that you can make the most of your finances at each stage.

The Accumulation Phase

The accumulation phase is when you are working and saving for retirement. This financial phase typically begins around age 25, when a person starts their career, and continues as they advance in their profession.

During this phase of financial life, people typically have much more debt than equity (student loans, car loans, mortgage, etc). This is when human capital — the amount of potential future earnings throughout the remainder of your life — is the highest while financial capital — the amount of money already saved — is the lowest. As you move through the accumulation phase, wages tend to increase, debt begins to decrease, and a solid asset base begins to develop.

The main financial goal during this phase is wealth accumulation. You want to grow your assets so that you will have enough to support yourself in retirement while reaching other goals (child education, new home, etc) and keep earning enough money to pay off liabilities while increasing equity levels.

The biggest risk during this phase is losing your job or having a major unexpected expense, such as a medical emergency. The best way to protect yourself against these risks is to have an emergency fund and to diversify your investments. However, due to longer time horizons, accumulators often invest in riskier portfolios to increase expected growth.

The Preservation Phase

The preservation phase typically starts at age 55, when you are approaching retirement and have the highest level of financial capital.

During this financial phase, debt should be decreasing or disappearing altogether while wages should continue to increase. The main goal is to protect assets that have been accumulated, which means a more conservative investment approach focused on steady and less volatile returns.

One of the biggest risks during this phase is inflation, which can erode the purchasing power of your savings by the time you need them. Due to the shorter time horizon versus the accumulation phase, investing in riskier but higher-yielding assets could be dangerous. Strategies that can help manage inflation include diversification and allocations into inflation-protected investments such as TIPS.

The Distribution Phase

The distribution phase is when you begin withdrawing from your retirement accounts, typically around age 65. The goal during this phase is to make sure that you don’t run out of money.

While the distribution phase generally begins during the later retirement years, it can begin much sooner depending on your lifestyle, expenditures, and overall net worth. By the time they reach the distribution phase, a person is set in their lifestyle and should feel comfortable that they are financially able to live the rest of their lives. They maybe be able to afford things they never imagined possible.

Due to this excess of wealth, people sometimes begin buying gifts for their children/grandchildren (cars, vacations, college tuition, annual cash gifts). The focus of the overall portfolio begins to shift away from the original client and towards the next generations. Estate planning becomes more imperative and gifting strategies are developed. Since some of the assets are now being managed for the next generations, the time horizon of the assets can increase in the distribution phase, which can give the portfolio greater ability to accept risk again.

The biggest risk retirees face during this phase is longevity risk, which is the risk that you will outlive your savings, either due to excess lifestyle spending or unexpected healthcare expenses. Having a financial plan that includes a decumulation strategy and takes into account potential healthcare costs, including long-term care needs, can help protect them from the risk of running out of money.

The Phases Are Not Exclusive

As you can see, each of the three financial phases of life has its own unique characteristics, but this does not mean that they are is mutually exclusive. On the contrary, these phases tend to blend together quite often. Accumulation often runs over to preservation as you keep contributing money to retirement while becoming more conservative near retirement. Similarly, preservation can run into the distribution phase as you continue protecting your assets while beginning to gift them to the next generation. Accumulation can even run into distribution on rarer occasions.

Financial Planning Becomes Increasingly Important

While financial discipline is important regardless of where you are in life, financial planning becomes increasingly important as you approach and go through preservation and distribution due to the shorter time horizon, reduction in human capital, and the risk of running out of money when you’re not longer able to work.

The best way to create a financial plan that helps you reach your financial goals, build wealth, and enjoy retirement is to work with a professional financial advisor. Advisors understand the many investment and insurance products available, the importance of tax planning, and can be your financial partner throughout life and into retirement, helping you provide for yourself and your family. If you’re not currently working with an advisor, or are considering a second opinion about your financial plan, get started today by requesting a free, no-obligation consultation with your local member of our advisor network.