We are all aware that life has different phases – and that there are many ways to define these phases. The one referring to Santa Claus is probably one of the funniest, but it might not be very useful when we think about the best strategy for investing our money.
In personal finance, it is more useful to define each life phase by the difference between our revenues and our expenses.
When making an investment decision, many people only consider their current financial situation. This is not enough, because both the money we earn, our revenues, and the money we spend, our expenditures, vary throughout our life. Since our decisions not only impact our financial situation today but have also consequences for many years to come, it is necessary to foresee the main phases of our life and to understand how each of them will impact our future financial situation. This is financial planning.
In an ideal situation, revenues should be high enough to cover our living costs and to put some money aside for a rainy day. But this is not always possible.
There are phases in our life, where our expenditures tend to be higher than our revenues. This is normally the case for students, who have to rely on pocket money from their parents, occasional allowances by aunts or grand-parents or on earnings from holiday jobs. It is also typically the case for parents paying for their children’s higher education, or for retired people, who may need to draw on previous savings or capital, or even borrow money.
Middle-aged people in the prime of their earning potential, however, often earn more money than they need to cover their living costs. That’s the phase when they can allow themselves a more comfortable lifestyle, while putting some money aside. That’s also the phase when they can afford to invest and to take some financial risks.