One Size Doesn’t Fit All: 10 Reasons Money Management Differs for Time-Savers and Retirees

A reader asked an interesting question: Aren’t personal finance principles universal? My father and I have arguments over our financial decisions. This is to be expected. So much has already been written about how a person’s life stage influences their personal financial decisions. Can you compare and contrast the compensation stage with the retirement stage, he asked. This column is another attempt.

First, the risks to earnings in the gain phase come from human capital. In retirement, income risks arise from financial and physical assets. The main source of income is the profession, job or business when one is young. The skills one brings to the job and the demand for those skills in the marketplace determines how well a human asset can function and earn a stable, sufficient, and sustained income.

In retirement, income comes from pensions, assets or investments. While most argue that not having a job is risky, in reality, income control is better in retirement. The pension is not affected by the performance evaluation and is not at risk of losing one’s job. It remains as long as one is alive. Investment returns are subject to risk, but a large enough corpus and reasonable asset allocation can solve this problem satisfactorily.

Second, the adequacy of income and its ability to fight inflation, however, are very different. Pensions may not be enough. Their indexation to inflation may not be adequate. Even with smart asset allocation and investment management, an insufficient corpus cannot provide adequate and regular income. Retirement is limited by the ability to flex and change income levels. The earning phase enjoys tremendous ease in increasing income from new skills, new businesses, improved labor markets, multiple sources of income through moonlighting, and the ability to move up the career ladder.

Third, the presence of a potentially growing income stream provides better cushioning during income years for making portfolio construction and rebalancing decisions. For example, if adequate income is available and it is possible to save each month, a winning member’s portfolio may be overweight stocks. A retiree’s portfolio cannot be overstocked for two reasons: it must generate income and it must cover any significant decline in equity assets.

Fourth, the winner’s portfolio is more apt to perform tactical portfolio reviews and changes. A retiree’s portfolio needs to be managed more strategically. For example, we talk about taking advantage of a falling or falling market, to enter new long positions. Someone with a stable salary and an investable surplus is still able to deploy funds in a bear market. A retired person will not have this tactical advantage, as they may not have cash when an opportunity presents itself.

Fifth, a retiree’s portfolio will need to be strategically constructed and will not benefit from increases. The value of the portfolio is closely linked to the performance of the market. A bold equity allocation at the start can take a serious hit if the markets subsequently crash. The portfolio of an earning member benefits from regular increases in surpluses resulting from income growth over the years. Many of them have seen their savings rate increase significantly as they earn better over the years. They may be able to spend and save more. A retired investor’s portfolio increases come solely from returns on his assets, not from contributions of surpluses.

Sixth, the portfolio of a retired person may be geared towards realized gains and reallocations, while the portfolio of a person earning an income may be geared towards the possibility of realizing unrealized gains. Laddering and rebalancing are valuable strategies for retirees. Reserving earnings from growth assets and transferring them to the income portfolio is often done to maintain strong earnings and to prevent equity allocations from getting too high. However, they end up exiting winning assets prematurely. Since the earning member’s portfolio has no income requirement, it can allow profits to run and focus on mitigating losses when they occur.

Seventh, an earning member is able to use leverage to increase their earnings and fund their income needs without liquidating the portfolio. They can borrow against their assets, using their earnings to repay those loans while protecting their assets. A retiree’s ability to borrow and repay loans is limited. Both through a limited revenue stream and dependent on investment. A retired person with surplus income might be conservative in their spending habits or in the allocation of their investments, or both. They may therefore be reluctant to borrow, even if they can.

Eighth, a winning member’s portfolio benefits from being geared toward defined financial goals. The execution rate of the portfolio, or the required rate of return, is defined by the funding required for the financial objective. Savings and investment are suitable for this calculation. A retired investor enjoys the luxury of not having to worry about funding their financial goals. The corpus left to the heirs can be treated as residual once their needs have been met.

Ninth, a retired person does not need life insurance, although health insurance needs can be high and expensive. A young remunerated investor needs life insurance first, before building up assets. Health insurance may be provided by the employer or may be available at cheaper rates. A retired person is able to use their assets in an emergency; a young, rewarding investor may not yet have built up the right assets. Insurance is the protection until then.

Tenth, a winning investor may be eager to acquire assets and build wealth, distorting his portfolio in the attempt to do so. Someone who buys a house early in their career will most likely have all of their wealth in one property. The retired investor should ideally have a balanced mix of assets – equity, debt and real estate. If their portfolio is also skewed, it can become a constraint to generate income and protect against inflation.

Many of these contrasts are well known. This list contrasts how the fundamentals of risk, return, income, growth, borrowing, surplus, strategic and tactical asset allocation are very different for those earning a income and those who may have retired. These differences determine how portfolios will be constructed, reviewed and rebalanced. In personal finance, there really is no generalization; each person may have their own goals and constraints.

(The author is PRESIDENT OF THE CENTER FOR INVESTMENT EDUCATION AND LEARNING)

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