Life-Cycle Investing

Raj & Rakshita, aged 37 and 35 are today’s working couple with a daughter and son.  After taking into account all their expenses between them they have a surplus income of roughly Rs.1.5 Lakhs annually.  They have invested this surplus mostly in several insurance policies.  Endowment, money back, return of premium plans and recently unit linked plans also.  The couple’s insurance advisor has sold them these plans over several years.  Two major events in the future, children education and marriage and their own retirement need is being met through the proceeds of these insurance plans. 

Meet Gopal and  Krithika,  aged 36 and 32 with daughter.  Gopal works for a leading retail chain and Krithika is the home maker.  This family also has almost Rs.1.5 Lakhs annual investible surplus.  Gopal does not believe in investing in insurance or such ‘less-risk’ avenues.  He is an aggressive investor in shares and stocks and also into ‘trading’ in stocks.  He firmly believes that in the long term only equity investment would give him the kind of returns he needs to build the corpus for his daughter’s education and marriage expenses and their own retirement needs. 

Between these two families, what’s common and what’s not?  Life cycle needs like children education and marriage expenses and planning for retirement is a common thread.  However, choice of financial instruments to meets these goals is vastly different.  Raj & Rakshita has chosen the ‘less-risk’ option of investing in insurance (this is not fully true in case of unit linked plans) whereas Gopal & Krithika have choose the other option at the other end of the spectrum viz., investing directly in to stocks and shares. 

Before a financial planner can say whether these two approaches help the respective families to meet their goals, it would be better to understand what’s meant by life-cycle investing. Depending on the earning capability, age and the current level of accumulated wealth, investors are broadly classified in one of the four stages of the life cycle: accumulation, consolidation, spending (withdrawal), or gifting.  

According to the theory of Lifecycle investing, each individual will go through various lifecycle stages, in which the investment needs are different.  

Accumulation phase (Age Twenties and Thirties) 

When younger, the individuals are able to invest in higher risk assets and follow an aggressive investment strategy, designed to provide maximum long term growth. Some examples of such assets are equities and mutual funds. 

Consolidation Phase (Age Forties and Fifties) 

In mid-life the individual has accumulated assets to cover the important needs like housing, children education and marriage expenses and is now looking for opportunities to increase wealth generation. In this phase, the individual would have more resources to devote to investment, but might want to take a less risky approach. There is a need to rebalance the asset allocation now and move towards less-risk options like Hybrid Funds or Debt Funds.  Some portion of exposure to equity investment may still be needed to take care of effect of inflation. 

Spending Phase (Age Sixties and Seventies) 

The third phase is the ‘spending’ or ‘decumulation phase’ during which the individual is no longer working and is living on the income and capital accumulated in the first two phases. Loss of capital owing to investment in higher risk assets is not acceptable to the investor in this phase.  Asset allocation will mainly be skewed towards Govt. Bonds and securities yielding regular income. 

Gifting Phase (Age Eighties and Nineties) 

Finally, there is the ‘gifting’ phase, in which individuals who have accumulated far more wealth than they will need for their own lifetimes, decide to pass some of their assets on to others.  The ‘life cycle’ theory suggests that, as individuals move through these phases, their investment needs and objectives change significantly and, while being able to hold mostly risk bearing assets when young the individual needs to eliminate most investment risk as they grow old. 

The Ages mentioned against each phase may vary depending on the financial status and attitude of the individual towards work.  It’s not very uncommon to see people who now retire in their forties or early fifties.  This will only increase the length of spending phase which is longer than accumulation and consolidation. Also, health condition and lifestyle are important factors in deciding the longevity of the individual.  Improved healthcare facilities and comfortable lifestyle lead to increased longevity. 

Having known investment life-cycle, now we can analyse the decisions made by the couples Raj & Rakshita and Gopal and Krithika. Each phase of life have their own imperatives and asset allocation strategies.  One-size-fits-all may not work in all phases of life.  Raj & Rakshita, with their reliance on insurance policies to meet their life cycle needs may woefully fall short of their needs.  Gopal and Krithika with their aggressive attitude towards investment may face the scenario or loss of capital. 

Financial markets and products have developed significantly, since the Lifecycle theories first gained popularity. It is now important for investors of all ages to consider their investment options in a more balanced manner. Sophisticated risk-management strategies are commonly employed by large corporations, however such modern techniques are yet to find wider usage by individual investors to plan their investment portfolios over the four life-cycles mentioned above.