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We are all familiar with the “Ready, Set, Go” announcement before a track race as runners prepare, get positioned to run, and finally start. Financial readiness is akin to this. You have to be in a state of readiness to successfully approach the race to your future financial life . But what exactly makes one “ready?”
Stages of Life
Being in a state of readiness depends somewhat on the stage of life you are in and your age. In broad terms, most investors under the age of 55 or 60 fall into the Accumulator phase. These folks are mostly concerned with building a financial asset foundation. Those within a decade or so of possible retirement fall into the Run Up phase. They are running up to the finish line for their working life. After retirement, investors go into the Maintain phase where the focus becomes maintaining pre-retirement lifestyle after living cost increases. Each phase has distinct requirements for being ready.Accumulator
For those individuals in the first stage (Accumulator), understanding human capital is a key to readiness. Human capital simply means your ability to earn money and then save/invest from those earnings. Most investors start out with a large amount of human capital and a small amount of investment capital. Readiness means that you recognize your human capital depletes each day and you are working to grow investment capitalto fill this gap.Run Up
For investors in the Run Up phase, readiness means coming to grips with a realistic vision of retirement and what the financial resources to back that up look like. Sometimes clients have a picture in their mind of a healthy couple walking along a sunny beach without a care in the world. More often than not, this picture doesn’t connect with their financial realities. They aren’t ready, at least from a financial perspective. For individuals with at least several years before retirement, there may still be time to adjust savings and gradually get set for retirement.Many years before you reach retirement is also a good time to fully understand the impact of living cost increases (inflation) and exactly how significantly this impacts the income needed to sustain your lifestyle for 25 years or longer. With 3% per year inflation, your expenses will roughly double in less than 25 years. The simple chart below depicts starting expenses of $100,000 per year and shows the income needed to maintain the same buying power in 10 year increments up to 30 years.
The Run Up phase is also where readiness requires that long-term debt obligations be paid so that flexibility can be maintained in retirement. Going into retirement with significant debt moves you away from readiness.Related: 14 Equations for a Sound Financial LifeFinally, financial mistakes are particularly painful in the Run Up phase as there is little time to recover before retirement. Making unwise bets late in the Run Up phase because you need to make up lost ground can backfire and have long-term lifestyle-altering consequences.