Investment Planning vs. Income Planning

Many people are unaware that there is a significant difference between investment planning, or the accumulation stage, of their lives, and the safety and asset distribution stage, referred to as income planning.

In this article, I will review what the differences are and when it is suitable for an individual to focus on which, as missteps can have a potentially adverse effect on the quality of an individual’s retirement. 

Investment Planning

First, I will focus on what will be the more familiar of the two, which is the area that most financial advisors most often specialize in. This is investment planning, also known as the accumulation stage of an individual’s life.

For most people, their initial exposure to investment and retirement planning comes with their first “real” or “adult” job. This is often their first employment to include benefits as part of their compensation package. These benefits often include health insurance, life insurance, disability insurance and a retirement account, such as a 401(k), 403(b), 457 or TSP.

For this young employee, probably in their mid-twenties to early thirties with a working time horizon of thirty or more years, it is usually agreed that the best practice is to select investment options typically tied to an at-risk index, like the S&P 500, or similar at-risk mutual funds.

During the next two to three decades, where the employee is working, saving and investing, this individual is in what is commonly referred to as the accumulation stage of their life.

Investing at this stage is easy for two reasons:

1. The employee has what I call ” the magic of time.” They can afford to withstand an investment mistake. They pay their monthly bills solely on the strength of their paycheck and do not currently need the money from their retirement account to sustain them.
2. The employee is actively contributing to their retirement account, often with employer matching. Fresh capital is being invested every month.

This combination of an investment horizon of five to forty more years of employment, along with a consistent stream of monthly contributions, provides protection against market volatility.

I like to explain market volatility simply as “the stock market goes up, we are happy; the market goes down, we are not happy.”

During the accumulation stage, with the above provisions in place and as long as the employee does not get “spooked” and stays the investing course, the final outcome is likely to be positive.

However, all of this comes to a halt as retirement comes into focus.

Income Planning

The last one to five years of a person’s active, full-time work, before their retirement, are, in my professional opinion, the most difficult years to manage the accumulated retirement assets.

During this stage of life, they are getting close to entering the distribution, and hopefully preservation, stage of their financial life.

They have reached the point where they have accumulated most of the assets that they will have for the rest of their lives.

They no longer have that “magic of time” discussed earlier, as they may not have enough time for a major market downturn to correct itself.

It is at this point in time than an individual may wish to remove some risk from the portfolio, not only in their employer retirement account, but also in any other investment accounts they own.

At this stage, I usually assist my clients in determining what the “paycheck replacements” or financial inflows, will be.

Most individuals no longer enjoy pension income. Their sole guaranteed monthly income will typically be Social Security, which is designed to replace approximately 35% to 40% of their previous active income.

We then examine the outflows, or mandatory monthly expenses. If expenses exceed the Social Security and other inflow item amounts, there is a monthly income shortage, or gap.

The challenge for this person now becomes determining the most effective way to transform the money they have spent their working lives creating into an income stream. Hopefully one that they will not outlive, will guard against the magnified risks of the stock market, will keep pace with inflation over, and will be able to handle potential healthcare expenses with typically occur as we age and are not covered by insurance.

You may have noticed that I mentioned significantly more risks for this stage than for the accumulation stage.

Another way to put this is that the accumulation of assets, which builds a large pot of money for future use, does not come with a structured distribution plan. There is no set way for a person to use their funds once their paycheck stops in retirement but the monthly bills continue.

There is a completely different strategy to income planning than to investment planning. It’s important to use the best strategy for your current stage of life.

The author drew upon personal experience in basic budgeting, income and retirement planning to craft this article, omitting formal references or footnotes.