By Allyn Hughes, CFP®, ChFC®, CLU®, CAP®
For many people, their 40s are a decade of change. Kids grow up, jobs may change and income and expenses could be volatile. Life transitions may require you to re-think short- and long-term personal financial goals and opportunities. Several factors that influence your long-term financial security need your attention.
Studies show that the average American worker changes jobs/career five to seven times. It is likely that one or both spouses will experience a career transition during their 40s. Making this transition often involves tradeoffs between income levels, job security, work and life balance and family needs. Some career decisions will improve your finances, others improve the quality of your life. It’s important that you closely weigh the advantages and disadvantages of any career change before you shift directions.
Key questions to ask yourself
Key financial questions during your 40’s might include: How much can I save consistently? In very general terms, you should have roughly three times your annual salary built up in savings by your early 40s and four times income by your late 40s. If you’re committed to saving early in your career and have had the luxury of employer matching to a retirement plan, this should not be a difficult hurdle. However, managing your expenses and living on less than you make can be difficult for people in their 40s. As careers become more established and income rises, often people in their 40s want to improve their current standard of living more than invest in their future financial freedom. In addition to saving and investing at least 10% of your gross income, make sure that you split the proceeds of any financial windfall (e.g., bonus check, inheritance, large tax refund) so that some cover current needs but the remainder is invested for your future needs.
How should I invest?
Savings does the heavy lifting so that you have something to invest, but how you invest and how you manage your behavior around the psychological influences of fear and greed is important. People in their 40s have a long time horizon before needing to withdraw their savings to supplement retirement income, but that doesn’t mean than every 40-something should be an aggressive investor. Whether you are conservative or aggressive, the best investment approach for you is one that you can stick with through a variety of market conditions and economic changes. As soon as you try to time markets, shifting to more aggressive positions when you are comfortable and more conservative positions when you are worried, you cause problems for yourself. Settle on a globally balanced mix of stocks and bonds, manage your costs and keep adding to your accounts.
How do I manage education costs?
Education costs tend to be larger for people in their 40s and 50s. Even before college, expenses for many kids’ activities can become a significant part of your budget. This can make it challenging to accrue funds for college costs while also adequately funding your own retirement security. Consider communicating expectations with your kids about how much you will be willing to pay for college. They can then figure out how to get the balance of the money they need from scholarships, grants, loans and summer jobs. Do not sacrifice your retirement saving to pay for education costs. You have only one chance to save enough for a comfortable retirement.
Is risk protection important?
Yes. Low-cost term life insurance for periods up through your planned retirement age, is critical for many people. Life insurance helps protect against the risk of a premature death of one of the spouses. General rule-of-thumb is to buy enough insurance coverage to pay for three key future expenses that the insured would have faced: 1) pay off the home mortgage, 2) allow the surviving spouse to not work for as much as two years while he/she is grieving, and 3) pay for college costs for children. Even if you have group life insurance through your employer, it is likely not enough to cover these liabilities. Your need for life insurance may decline over time and should be re-evaluated periodically. Just as important as life insurance is disability insurance. You are more likely to have an injury or illness that interrupts your income than you are to die prematurely. Again, it may be wise to add on to employer-provided disability insurance with a personal policy that can move with you and not be tied to your employment throughout your career.
Should you move up from a starter home to a nicer residence?
For some people, this question starts a step earlier; should I rent or buy a home? But, if you’ve had some financial success in your career, you’ve likely purchased a home before your 40s and may now wonder if it is the right home long-term or if you can afford to move upmarket. If you are not already adequately funding retirement savings, college savings and an emergency cash reserve, then the answer is that you should stay where you are. It can be tempting to think about moving to a new neighborhood, but remember that in addition to the purchase price of the home, you are likely resetting your mortgage for a new, longer term and increasing your property tax and insurance bills. Most people also find when they move that they want new or different furniture or fixtures for the new home and the expenses climb a little bit more. It’s nice to use the leverage of a lender’s money to buy a home in an environment where prices can be expected to appreciate. But remember that home equity is generally illiquid and there are risk and costs in using your home as a cash machine to fund goals rather than having separate savings for your non-residential expenses.
Should I have a financial plan?
Most people in their 40s don’t have a written set of goals and a way to analyze their progress toward them. Going through the process of creating a financial plan can be beneficial, because it allows people to establish goals for saving and investing, gives them better ideas of when and how they can afford to retire and helps predict how much annual income they could have in retirement. In some ways, a financial plan is more valuable to a 40-something than to someone near retirement, because the plan could identify several ways to influence financial security while you still have a lot of time to maximize it.
Additional questions to consider:
- Are your parents financially secure? Will you need to assist them in any way as they age? Can you expect any inheritance?
- Are my wife and I in sync with our goals, savings vs. spending and expectations for how we want to live and what we value?
- Have you completed a will, health care directive and any other necessary estate planning documents?
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