1

Age

Needs, desires, values, and priorities all change over a lifetime, and financial concerns change accordingly. Ideally, personal finance is a process of management and planning that anticipates or keeps abreast with such changes. Although everyone is different, some financial concerns are common to or typical of the different stages of adult life. Analysis of life stages is part of financial planning.

At the beginning of your adult life, you are more likely to have no dependents, little if any accumulated wealth, and few assets. Assets are resources that can be used to create income, decrease expenses, or store wealth as an investment. As a young adult, you also are likely to have comparatively small income needs, especially if you are providing only for yourself. Your employment income is probably your primary or sole source of income. Having no one and almost nothing to protect, your willingness to assume risk is usually high. At this point in your life, you are focused on developing your career and increasing your earned income. Any investments you may have are geared toward growth.

As your career progresses, income increases, but so does spending. Lifestyle expectations increase. If you now have a spouse and dependents and elderly parents to look after, you have additional needs to manage. In middle adulthood, you may also be acquiring more assets, such as a house, a retirement account, or an inheritance.

As income, spending, and asset base grow, ability to assume risk grows but willingness to do so typically decreases. Now you have things that need protection: dependents and assets. As you age, you realize that you require more protection. You may want to stop working one day, or you may suffer a decline in health. As an older adult, you may want to create alternative sources of income, perhaps a retirement fund, as insurance against a loss of employment or income. Table 1.1.2 suggests the effects of life stages on financial decision-making.

Table 1.1.2 Financial Decisions Related to Life Stages

	Young Adulthood	Middle Adulthood	Older Adulthood	Retirement
Source of Income	Wages	Wages / Investment	Wages / Investment	Investment
Asset Base	None	Accumulating	Growing	Using up
Expenses	Low	Growing	Growing	Low
Risk: Ability	Low	Higher	Higher	High
Risk: Willingness	High	Lower	Lower	Low

Early and middle adulthood are periods of building up: building a family, building a career, increasing earned income, and accumulating assets. Spending needs increase, but so do investments and alternative sources of income.

Later adulthood is a period of spending down. There is less reliance on earned income and more on the accumulated wealth of assets and investments. You are likely to be without dependents, as your children have grown up or your parents passed on, and without the responsibility of providing for them your expenses are lower. You are likely to have more leisure time, especially after retirement.

Without dependents, spending needs decrease. On the other hand, you may feel free to finally indulge in those things that you’ve “always wanted.” There are no longer dependents to protect, but assets demand even more protection as, without employment, they are your only source of income. Typically, your ability to assume risk is high because of your accumulated assets, but your willingness to assume risk is low, as you are now dependent on those assets for income. As a result, risk tolerance decreases: you are less concerned with increasing wealth than you are with protecting it.

Effective financial planning depends largely on an awareness of how your current and future stages in life may influence your financial decisions.

 

REFERENCES

CPA Canada. (2023). “2023 Canadian CPA Profession Compensation Study Results.” Retrieved from: https://www.cpacanada.ca/the-cpa-profession/about-cpa-canada/media-centre/2023/october/2023-canadian-cpa-profession-compensation-study-results.

Payscale. (2024). “Search Job Salaries.” Retrieved from: http://www.payscale.com/research/CA/Country=Canada/Salary.

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1.2 SYSTEMIC OR “MACRO” FACTORS THAT AFFECT FINANCIAL THINKING

Financial planning has to take into account conditions in the wider economy and in the markets that make up the economy. The labour market, for example, is where labour is traded through hiring or employment. Workers compete for jobs and employers compete for workers. In the capital market, capital (cash or assets) is traded, most commonly in the form of stocks and bonds (along with other ways to package capital). In the credit market, a part of the capital market, capital is loaned and borrowed rather than bought and sold. These and other markets exist in a dynamic economic environment, and those environmental realities are part of sound financial planning.

In the long term, history has proven that an economy can grow over time, that investments can earn returns, and that the value of currency can remain relatively stable. In the short term, however, that is not continuously true. Contrary or unsettled periods can upset financial plans, especially if they last long enough or happen at just the wrong time in your life. Understanding large-scale economic patterns and factors that indicate the health of an economy can help you make better financial decisions. These systemic factors include, for example, business cycles and employment rates.

Business Cycles

Ideally, an economy should be productive enough to provide for the wants of its members. Normally, economic output increases as population increases or as people’s expectations grow. An economy’s output or productivity is measured by its gross domestic product (GDP), the value of what is produced in a period. When the GDP is increasing the economy is in an expansion, and when it is decreasing the economy is in a contraction. An economy that contracts for half a year is said to be in recession; a prolonged recession is a depression. The GDP is a closely watched barometer of the economy. However, GDP can be considered a limited indicator of economic growth because it doesn’t measure goods and services that are not paid for. For example, caring for children or housework is not counted as part of GDP unless it is done by a daycare or a hired cleaner. Furthermore, GDP doesn’t account for negative externalities such as the “harm done by industrial pollution or the health costs resulting from a polluted water system; these should be accounted as debits to the national income. Conversely the benefits of clean water and clean environment are not counted within GDP” (Orr and Weir, 2013, p. 110).

Over time, the economy tends to be cyclical, usually expanding but sometimes contracting. This is called the business cycle. Periods of contraction are generally seen as market corrections, or the market regaining its equilibrium, after periods of growth. Growth is never perfectly smooth, so sometimes certain markets become unbalanced and need to correct themselves. Over time, the periods of contraction seem to have become less frequent. The business cycles still occur nevertheless.

There are many metaphors to describe the cyclical nature of market economies: “peaks and troughs,” “boom and bust,” “growth and contraction,” “expansion and correction,” and so on. While each cycle is born of a unique combination of circumstances, cycles occur because things change and upset economic equilibrium. That is, events change the balance between supply and demand in the economy overall. Sometimes demand grows too fast and supply can’t keep up, and sometimes supply grows too fast for demand. There are many reasons that this could happen, but whatever the reasons, buyers and sellers react to this imbalance, which then creates a change.

Employment Rate

An economy produces not just goods and services to satisfy its members, but also jobs, because most people participate in the market economy by trading their labour and most rely on wages as their primary source of income. The economy must therefore provide opportunities to earn wages so more people can participate in the economy through the market. Otherwise, more people must be provided for in some other way, such as a private or public subsidy (charity or welfare).

The unemployment rate is a measure of an economy’s shortcomings, because it shows the proportion of people who want to work but don’t because the economy cannot provide them jobs. There is always a so-called natural rate of unemployment, as people move in and out of the workforce as the circumstances of their lives change—for example, as they retrain for a new career or take time out for family. But natural unemployment should be consistently low and not affect the productivity of the economy.

Unemployment also shows that the economy is not efficient, because it is not able to put all its productive human resources to work.

The employment rate shows how successful an economy is at creating opportunities to sell labour and efficiently using its human resources. Statistics Canada defines the employment rate as “the number of employed people as a percentage of the population aged 15 and older. The rate for a particular group (for example, youths aged 15 to 24) is the number employed in that group as a percentage of the population for that group” (Statistics Canada, 2024, p. 5). In contrast, the participation rate includes both unemployed and employed Canadians, or, as Stats Canada puts it, “The participation rate is the number of employed and unemployed people as a percentage of the population” (Statistics Canada, 2024, p. 5). According to Robert Oppenheimer (2024), “there is a clear relationship between the level of educational attainment and the rates of unemployment, employment, and participation.”

A healthy market economy uses its labour productively, is productive, and provides employment opportunities as well as consumer satisfaction through its markets. Table 1.2.1 shows the relationship between GDP and unemployment and each stage of the business cycle.

Table 1.2.1 Cyclical Economic Effects

	Boom	Expansion	Recession	Depression
Rate of GDP Increase	Unsustainably High	Positive	Negative	Unsustainably Low
Rate of Unemployment	Unsustainably Low	“Natural” or Minimal	Higher	Unsustainably High

At either end of this scale of growth, the economy is in an unsustainable position: either growing too fast, with too much demand for labour, or shrinking, with too little demand for labour.

If there is too much demand for labour—more jobs than workers to fill them—then wages will rise, pushing up the cost of everything and causing prices to rise. Prices usually rise faster than wages, for many reasons, which would discourage consumption that would eventually discourage production and cause the economy to slow down from its “boom” condition into a more manageable rate of growth.

If there is too little demand for labour—more workers than jobs—then wages will fall or, more typically, there will be people without jobs, or unemployment. If wages become low enough, employers will (theoretically) be encouraged to hire more labour, which would bring employment levels back up. However, it doesn’t always work that way, because people have job mobility—they are willing and able to move between economies to seek employment.

If unemployment is high and prolonged, then too many people are without wages for too long, and they are not able to participate in the economy because they have nothing to trade. In that case, the market economy is just not working for too many people, and they will eventually demand a change (which is how most revolutions have started).

Other Indicators of Economic Health

Other economic indicators give us clues as to how “successful” our economy is, how well it is growing, or how well positioned it is for future growth. These indicators include statistics, such as the number of houses being built or existing home sales, orders for durable goods (e.g., appliances and automobiles), consumer confidence, producer prices, and so on. However, GDP growth and unemployment are the two most closely watched indicators because they get at the heart of what our economy is supposed to do: provide diverse opportunities for the highest number of people to participate in the economy, to create jobs, and to satisfy these individuals’ needs.

An expanding and healthy economy will offer its participants more choices—namely, more choices for trading labour and for trading capital. It offers more opportunities to earn a return or an income and therefore also offers more diversification and less risk.

Naturally, everyone would rather operate in a healthier economy, but this is not always possible. Financial planning must include planning for the risk that economic factors will affect one’s financial realities. A recession may increase unemployment, lowering the return on labour—wages—or making it harder to anticipate an increase in income. Wage income could be lost altogether. Such temporary involuntary loss of wage income will probably happen to you during your lifetime, as you inevitably will endure economic cycles.

A hedge against lost wages is investment to create other forms of income. In a period of economic contraction, however, the usefulness of capital, and thus its value, may decline as well. Some businesses and industries are considered immune to economic cycles (e.g., public education and health care), but overall, investment returns may suffer. Thus, during your lifetime business cycles will likely affect your participation in the capital markets as well.

Currency Value

Stable currency value is another important indicator of a healthy economy and a critical element in financial planning. Like anything else, a currency’s value is based on its usefulness. We use currency as a medium of exchange, so its value is based on how it can be used in trade, which in turn is based on what is produced in the economy. If an economy produces little that anyone wants, then its currency has little value relative to other currencies, because there is little use for it in trade. So, a currency’s value is an indicator of how productive an economy is.

A currency’s usefulness is based on what it can buy, or its purchasing power. The more a currency can buy, the more useful and valuable it is. When prices rise or when things cost more, purchasing power decreases; the currency buys less and its value decreases.

When the value of a currency decreases, an economy has inflation. Its currency has less value because it is less useful—that is, less can be bought with it. Prices are rising. It takes more units of currency to buy the same amount of goods. When the value of a currency increases, on the other hand, an economy has deflation. Prices are falling; the currency is worth more and buys more.

For example, say you can buy five video games for $20. Each game is worth $4, or each dollar buys one-quarter of a game. Then we have inflation, and prices—including the price of video games—rise. A year later you want to buy games, but now your $20 only buys two games. Each one costs $10, or each dollar only buys one-tenth of a game. Rising prices have eroded the purchasing power of your dollars.

If there is deflation, prices fall, so maybe a year later you could buy ten video games with your same $20. Now each game costs only $2, and each dollar buys half a game. The same amount of currency buys more games: its purchasing power has increased, as has its usefulness and its value. Table 1.2.2 provides an overview of how prices, purchasing power, and currency value change during periods of inflation and deflation.

Table 1.2.2 Dynamics of Currency Value

	Inflation	Deflation
Prices	Rise	Fall
Purchasing Power	Decreases	Increases
Currency Value	Falls	Rises

Inflation is most commonly measured by the consumer price index (CPI), which is a measure of inflation or deflation based on a national average of prices for a “basket” of common goods and services purchased by the average consumer as determined by the federal government. It is an accepted way of tracking rising or falling price levels, and as such is indicative of inflation or deflation.

Currency instabilities can also affect investment values, because the dollars that investments return don’t have the same value as the dollars that the investment was expected to return. Say you lend $100 to your sister, who is supposed to pay you back one year from now. There is inflation, so over the next year, the value of the dollar decreases (it buys less as prices rise). Your sister does indeed pay you back on time, but now the $100 that she gives back to you is worth less (because it buys less) than the $100 you gave her. Your investment, although nominally returned, has lost value: you have your $100 back, but you can’t do as much with it; it is less useful.

If the value of currency—the units in which wealth is measured and stored—is unstable, then investment returns are harder to predict. In those circumstances, investment involves more risk. Both inflation and deflation are currency instabilities that are troublesome for an economy and also for the financial planning process. An unstable currency affects the value or purchasing power of income. Price changes affect consumption decisions, and changes in currency value affect investing decisions.

It is human nature to assume that things will stay the same, but financial planning must include the assumption that over a lifetime you will encounter and endure economic cycles. You should try to anticipate the risks of an economic downturn and the possible loss of wage income and/or investment income. At the same time, you should not assume or rely on the windfalls of an economic expansion.

 

Brittany’s income will be used to meet her goals, so it’s important for her to understand where her income will be coming from and how it will help in achieving her goals. She needs to assess her current situation.

Assessing the Current Situation

Figuring out where you are, or assessing the current situation, involves understanding what your present situation is and the choices that it creates. There may be many choices, but you want to identify those that will be most useful in reaching your goals.

Assessing the current situation is a matter of organizing your personal financial information into summaries that can clearly show different and important aspects of your financial life—your assets, debts, incomes, and expenses. These numbers are expressed in financial statements—in an income statement, balance sheet, and cash flow statement (topics discussed in Chapter 3 “Financial Statements”). Businesses also use these three types of statements in their financial planning.

For now, we can assess Brittany’s situation by identifying her assets and debts and by listing her annual incomes and expenses; that will show if she can expect a budget surplus or deficit. But more importantly, it will show how possible her goals are and whether she is making progress toward them. Even a ballpark assessment of the current situation can be illuminating.

Brittany’s assets may be a car worth about $5,000 and a savings account with a balance of $250. Her debts include a student loan with a balance of $53,000 and a car loan with a balance of $2,700. These are shown in Table 1.3.2.

Table 1.3.2 Brittany’s Financial Situation

Assets	Debts
Car: 5,000	Car Loan: 2,700
Savings: 250	Student Loan: 53,000
Total: 5,250	Total: 55,700

Brittany will have an annual budget surplus of just $400. She will be achieving her short-term goal of reducing debt, but with a small annual budget surplus it will be difficult for her to begin to achieve her goal of accumulating assets. Once she gets her nursing degree and begins working as a nurse, she should see that small annual budget surplus significantly increase.

For now, to reach that intermediate goal, she will have to increase income or decrease expenses to create more of an annual surplus. When her car loan is paid off next year, she hopes to buy another car, but she will have at most only $650 ($250 + $400) in savings for a down payment for the car, and that assumes she can save all her surplus. When her student loans are paid off in about five years, she will no longer have student loan payments, and that will increase her surplus significantly (by $7,720 per year) and allow her to put that money toward asset accumulation and her graduate degree. Brittany’s long-term goals also depend on her ability to accumulate productive assets, as she wants to be able to quit working and live on the income from her assets in retirement. Brittany is making progress toward meeting her short-term goals of reducing debt, which she must do before being able to work toward her intermediate and long-term goals. Until she reduces her debt, which would reduce her expenses and increase her income, she will not make progress toward her intermediate and long-term goals.

Assessing her current situation allows Brittany to see that she has to delay accumulating assets until she can reduce expenses by reducing debt (and thus her student loan payments). She is now reducing debt, and as she continues to do so, her financial situation will begin to look different, and new choices will be available to her.

Brittany learned about her current situation by compiling two simple lists: one of her assets and debts, and the other of her income and expenses. Even in this simple example it is clear that the process of articulating the current situation can put information into a very useful context. It can reveal the critical paths to achieving goals.

Evaluating Alternatives and Making Choices

Figuring out how to go from here to there is a process of identifying immediate choices and longer-term strategies or series of choices. To do this you have to be both realistic and imaginative about your current situation; this will allow you to see the choices you are presented with and the future choices that your current choices may create. The characteristics of your living situation—family structure, age, career choice, and health—and the larger context of the economic environment will affect or define the relative value of your choices.

After you have identified alternatives, you must evaluate each one. The obvious things to look for and assess are its costs and benefits, but you also want to think about its risks, where it will leave you, and how well positioned it will leave you to make the next decision. You want to have as many choices as you can at any point in the process, and you want your choices to be diversified. That way you can choose with an understanding of how this choice will affect the next choice, and the next, and so on. The further along in the process you can think, the better you can plan.

In her current situation, Brittany is reducing debt, an obligation for which she is liable, so one choice would be to continue on this path. She could begin to accumulate assets—cash or property with a monetary value—sooner if she could reduce expenses to create more of a budget surplus (Kapoor et al., 2023). Brittany looks over her expenses and decides she really can’t cut them back much. She decides that the alternative of reducing expenses is not feasible. She could increase income, however. She has two choices: work a second job or go to Las Vegas to play poker.

Brittany could work a second, part-time job that would increase her after tax income but leave her more tired and with less time for other interests. The economy is in a bit of a slump too—unemployment is up a bit—so her second job probably wouldn’t pay much. She could go to Vegas and win big, with the cost of the trip as her only expense. To evaluate her alternatives, Brittany needs to calculate the benefits and costs of each, as in Table 1.3.4.

Laying out Brittany’s choices in this way shows their consequences more clearly. The alternative with the biggest benefit is the trip to Vegas, but that also has the biggest cost because it has the biggest risk: if she loses, she could have even more debt. That would put her further from her goal of beginning to accumulate assets, which would have to be postponed until she could eliminate that new debt as well as her existing debt.

Thus, she would have to increase her income and decrease her expenses. Simply continuing as she does now would no longer be an option because the new debt increases her expenses and creates a budget deficit. Her only remaining alternative to increase income would be to take the second job that she had initially rejected because of its implicit cost. She would probably have to reduce expenses as well, an idea she initially rejected as an unreasonable choice. Thus, the risk of the Vegas option is that it could force her to “choose” alternatives that she had initially rejected as too costly.

 

The Vegas option becomes least desirable when its risk is included in the calculations of its costs, especially as they compare with its benefits.

Its obvious risk is that Brittany will lose wealth, but its even costlier risk is that it will limit her future choices. Without including risk as a cost, the Vegas option looks attractive—which is, of course, why Vegas exists. But when risk is included, and when the decision involves thinking strategically not only about immediate consequences, but also about the choices it will preserve or eliminate, that option can be seen in a very different light.

You may sometimes choose an alternative with less apparent benefit than another but also with less risk. You may sometimes choose an alternative that provides less immediate benefit but more choices later on such as education. Risk itself is a cost and choice a benefit, and they should be included in your assessment.