Understanding The Ten (10) Financial Stages of Life
The Cambridge Financial Life Cycle is a benchmark that divides
your life into ten typical financial stages. There are specific wealth building
strategies for each stage and financial ratios that mark the transition from one
stage to the next.
The Formative Stages
The first three stages are The Formative Stages. These include:
- Toddler Years (0-5)
- Childhood Years (6-12)
- Teenage Years (13-19)
It is during these years that we acquire our beliefs about
money. Most of these beliefs are acquired by the time we are 12 years old. Our money
beliefs are derived from our family of origins, our childhood experiences and the
economic age in which we grew up. Those beliefs may be shaped one last time during
the teenage years.
Many of the beliefs acquired during our formative years are
dysfunctional. Dysfunctional does not mean you need to consult a therapist, although
in some cases that may be your advisor’s recommendation. Dysfunctional simply means
a belief about money that does not work. We all have such dysfunctional money beliefs,
even financial advisors.
In our Toddler years (0-5) we have no beliefs about
money. From our behavior, it appears we believe money is something to eat! Our parents
help us overcome this first dysfunctional belief, when they teach us, “Don’t eat
As our intellectual capacity grows, we enter the Childhood
years. In this stage our parents pass on more beliefs about money. They may give
us a piggy bank or help us open a savings account to teach us the concept of accumulation
or saving. When they take us shopping we learn the concept of convertibility. When
they tell us that a dime is worth more than a nickel even though the nickel is bigger,
we learn the concept of relative value.
During our Teenage Years, we may reject or adapt our
parents’ beliefs as we develop our own money belief system.
In the teenage years we usually experience our first job and
hopefully acquire three more valuable financial beliefs:
- Income is earned by exchanging labor/services for money
- Budgeting or cash flow management
- Money makes money
Often people get stuck at this stage or the next because they
have not fully understood the importance of concept #3 – Money makes money.
This refers to the magical power of compounding. Comprehending the increasing power
of money to make money provides motivation to save and invest. Can you envision
your “pile of money” growing through the magical power of compounding? Can you imagine
it becoming so big that it makes more money annually than what you earn at your
job? Belief #3 that money makes money is the key to financial independence and peace
Dysfunctional spending or savings behaviors are caused by
dysfunctional emotions which are triggered by dysfunctional beliefs. In Charles
Dickens novel, The Christmas Carol, Ebenezer Scrooge illustrates the devastating
impact of dysfunctional beliefs about money. In Scrooge’s mind, accumulating and
hoarding money triggered powerful emotions of satisfaction and security. Fortunately
for him, the ghosts of Christmas changed his dysfunctional beliefs. For many Americans,
spending triggers only emotions of pleasure. The Great Recession appears to be changing
some of the dysfunctional beliefs that trigger those emotions.
Is either saving or spending a problem behavior for you? Then
ask yourself why. What do you believe about saving/spending that make it a problem
Overcoming dysfunctional money beliefs is a journey of intellectual
and emotional development. We call it the Journey to FIPOM. FIPOM is an acronym
for Financial Independence & Peace Of Mind. We earn, spend and accumulate money
because we want to feel free and happy. (To learn more about your money personality
and the road to FIPOM read Facing Financial Dysfunction – Why Smart People Do Stupid
Things with Money!, pp.1-56, by Bert Whitehead, MBA JD.)
The Accumulation Stages
The next three stages are the Accumulation Stages. These include:
- Building the Foundation Years (20-29)
- Early Accumulation Years (30-49)
- Rapid Accumulation Years (40-54)
During the formative years we acquire our beliefs about money.
During the accumulation years we put those beliefs into practice. To track progress
through these stages we measure the ratio of our net worth to our gross income.
Because we have different standards of living, using the ratio of our net worth
to income is much more useful than comparing the size of our financial portfolios.
When we graduate from high school or college, we enter the
Building the Foundation years. At this stage our net worth is usually less than
our annual income. Our income makes us feel as if we are rich. This may be our first
taste of financial freedom because we are no longer dependent on our parents for
Building a pile of money big enough to give us freedom from
work requires laying a solid foundation. We lay this foundation with The Five Fundamentals
of Fiscal Fitness. People who practice all five fundamentals, move through all the
stages of the financial life cycle.
When your net worth equals your income (1x) you transition
into the Early Accumulation years. Implementing the Five Fundamentals of Fiscal
Fitness will triple your net worth during this stage. As your wealth grows, so does
your capacity to take on more risk. You can become more aggressive in your asset
allocation. See the Asset Allocation row in the Cambridge Financial Life Cycle.
When your net worth exceeds 3x annual income, you have most
likely entered the Rapid Accumulation years. During this stage the magical power
of compounding begins to kick in. Your investment earnings often exceed your savings.
In some years your investment earnings will exceed your job earnings. As you experience
the power of money to make money, the belief becomes reality.
You may also be approaching your peak earning years. The combination
of growing wealth and increasing income further enlarges your risk capacity. During
this stage your asset allocation plan is designed to focus your risk where you can
build wealth the fastest. Before long your net worth increases to 7x your annual
income and you enter what is for many the most enjoyable and yet challenging stages
of the financial life cycle.
The Conservation Stages
There are two conservation stages. They are:
- Financial Independence Years (55-69)
- Conservation Years (70-84)
The Financial Independence years are a transitional
period between the accumulation years and retirement. For many these are the peak
earning years. Your portfolio regularly generates income that is equal to 50% or
more of your annual living expenses. At this stage, our life may be more than half
over and time becomes more important than increasing our standard of living. Many
people begin to freeze their standard of living, in order to have more freedom with
their time. The focus now changes from your gross income to your living expenses.
We need a new ratio to measure your progress. The key ratio from now on is the size
of your financial portfolio to your annual living expenses.
If you are willing to freeze your standard of living, you may experience Financial
This is a transitional stage because you can start doing what
you really want to do. You can start your own business or semi-retire. You can change
careers or work part-time at a job you love. All these choices are possible for
you because you can supplement your earned income with income from your portfolio.
This can be a very enjoyable, but also very challenging transition.
In order to generate the stable income necessary for covering up to 50% of your
living expenses, you must reduce the risk in your portfolio. For more than 30+ years,
accumulation has taken priority over conservation; growth and volatility have taken
priority over safety and predictability. Now preserving wealth becomes more important
than accumulating, and safety becomes more important than growth. Psychologically
it can be a very difficult change to make. To reduce the portfolio’s exposure to
stocks, even modestly, when your capacity for risk is at its height, often seems
“wasteful”. But as advisors we always ask, “Why should you risk going backwards,
if you have already arrived?” You have achieved Financial Independence (FI), so
why not also secure Peace of Mind (POM) by changing your asset allocation to emphasize
both Conservation and Accumulation equally?
Even with a more conservative asset allocation and the withdrawal
of income, the power of compounding and additional saving continue to work their
magic. The portfolio continues to grow because inflows still exceed outflows. Depending
on your age and other sources of income, when your financial portfolio reaches 10-15X
your annual living expenses you have entered the Conservation years. You can stop
working entirely, if that is your desire, and live off your pension and investment
The Distribution Stages
There are two distribution stages. They are:
- Distribution Years (85+ )
- Sunset Years (Less than 12 months to live)
When your portfolio exceeds 15 times your living expenses
you have entered the Distribution years. You have more wealth than you can spend
in your lifetime without violating some of your deepest values about stewardship.
It is time to convert your wealth into a financial legacy that will influence future
generations long after you are gone. Increase gifts to charities that match your
values and promote your favorite causes. Take your children on a cruise or in other
ways initiate family events that your children and grandchildren will always remember.
”Invest in memories” that leave a legacy and shape future generations. Review
and put the final touches on your values-based estate plan. The manner in which
you distribute your wealth gives you one more opportunity to pass on the values
that contributed to your own happiness and success.
We enter the final stage, called Sunset, when we have
less than 12 months to live. Most of us will not know when we enter this stage.
For those who have not created their estate plan, the focus is on distributing assets
and reducing estate taxes.