Financial plans for a lifetime
For many people, financial planning consists of determining if the amount they have or will have saved by the time they retire, will provide adequate funding to live the retirement they desire. We take a broader view of comprehensive financial planning. Using the Bodie Merton Samuelson theory of life-cycle savings and investing (LCSI), we help clients identify their lifetime planning goals.
With the LCSI Approach, the most important lifetime financial asset is typically “human capital.” Human capital is defined as the present value of a person’s lifetime earned income. Unless one receives a significant inheritance, income from human capital will far exceed all other types of lifetime income.
Comprehensive financial planning entails understanding that human capital is the primary determinant of one’s long-term financial well being. Human capital must be managed, cultivated and protected, as one would with their savings and investments. One way to increase human capital is by attaining an education that provides for more human capital income during working years. Human capital must also be protected with adequate disability and life insurance.
The LSCI approach recognizes that people are more concerned about their lifetime standard of living than they are about their portfolio wealth. While helping a client’s assets grow is an important aspect for any financial advisor, the most critical aspect of comprehensive financial planning is assuring that the client’s total financial resources will allow them to maintain their lifetime living standards.
Spending is the use of financial resources to meet one’ needs and wants. Needs and wants may vary, based upon a person’s lifestyle. Comprehensive, lifetime financial planning helps people identify and differentiate their needs, such as food, shelter, transportation and other day to day living expenses, from their wants or desires. Wants may include exotic vacations and expensive cars, which are not required to maintain one’s standard of living. LSCI helps assure that lifetime financial resources will meet one’s needs and ideally, many of their wants.
There are four possible lifetime sources of income. Typically, the greatest income source is a person’s human capital, earned over his/her working years. A second source of income, upon retirement, is pensions and/or Social Security. For some people, an inheritance is their third source of lifetime income. For people fortunate enough to receive a significant inheritance, this additional income can often provide for many of the beneficiary’s desires, that may not have been otherwise obtainable. Unfortunately, less than 2% of all baby boomers will receive an inheritance of $500,000 or more. Thus, the vast majority of baby boomer and younger generations will not get a significant amount of lifetime income from inheritances.
The fourth source of income is saved and invested wealth. This income comes from a) the amount a person saves from their human capital (earned income) throughout their working career and b) the ability to wisely invest these savings for income and growth throughout both their working careers and in retirement. Effectively saving and investing can have a significant impact on this source of income.
The other half of the LSCI equation is uses of lifetime income. The first use is spending for both needs and wants. It is important to differentiate between needs and wants to assure that there will be adequate lifetime income for one’s needs.
The second use of income is for the inevitable portion of our income required to pay taxes. A third use of income is for providing possible gifts and bequests. The fourth use of income is for insurance products that protect one’s human capital and property. This includes health, disability, life, property, liability and long-term care insurance. The final use of income is saving. The savings can then be invested to become a source of income.
Sources of lifetime income and the uses of lifetime income are always equal. Once this simple equation is understood, the LSCI approach becomes clear. Do you have a comprehensive lifetime financial plan?