HAHN: Understand the three stages of planning for retirement

I was looking forward to attending the spring National Association of Personal Financial Advisors Conference last week in Denver. A bonus was the Cincinnati Reds were scheduled to play the Denver Rockies. Instead of being in Denver, I attended a virtual conference.

Sarah Newcomb, director of behavioral science at Morningstar Inc., gave a presentation on reframing retirement. She had three segments:

Mindset matters

Newcomb shared results of studies around how people think and feel about money. There were three key areas: time horizon, belief about control, and social comparisons. Detriments to savings were short-term thinking, believing an individual has limited control and comparing ourselves to individuals we perceive to have more wealth.

Economics for everyone

When most people think about economics, the topic is “out there” and not directly affecting our day-to-day life. On a personal level, it’s simply about how we direct our limited resources to meet our needs in order to achieve long-term financial freedom.

Newcomb said, “In economics, we learn that there are only three ways to produce income—land, labor and capital. If you want to stop laboring [retire, reach financial independence, whatever], then you need to acquire the other two.

“Land creates income in all kinds of ways. You can rent it to others, sell the trees or other resources on the land, farm it, or just let its value appreciate over time.

“Labor, we all know about. … We typically think of three types of capital. Physical capital is stuff. For example, if you own a tractor, you can use it to produce value on your land, or you can rent it out to someone else. In both cases, the physical capital is creating value for you.

“Intellectual capital is the value of any assets you have based on legally protected ideas, like patents or books. Financial capital is just money itself.”

The real key to achieving financial freedom is understanding how our spending meets long-term needs and wants. Our income from labor is allocated to support three spending categories: past, present and future. I’m guilty of getting caught up with tracking where my spending goes. Newcomb suggests thinking of our personal economy like this:

“Your current labor income is divided up into payments toward money borrowed in the past, meeting the needs and wants of the present, and investing in income for your future. Directing your ‘future’ funds into land or capital slowly over time builds up income sources to eventually replace your income from labor.”

Personal economics in action

These concepts are great, but the real question is, how can I use this to help me save more?

The secret sauce is to blend what we know about economics with an understanding of financial psychology using simple, memorable rules of thumb.

For example, if you are a short-term thinker, look at your current financial stage of life. There are three stages. The first stage is that you only have income being generated from labor. As you save and invest, you move to stage two, where you will have labor and land/capital. The third stage is having no labor and just relying on land/capital.

One powerful suggestion was to identify a role model you can emulate. Newcomb recommends asking three questions:

◗ Who has reached a level of financial freedom?

◗ How did that individual use land and capital to achieve this status?

◗ What’s one non-financial skill or resource that helped that person succeed?

It is possible to change your money mindset gradually over time. Looking at developing rules of thumb, thinking about your ability to make changes in your life and thinking long term will make an impact in your ability to reach financial freedom however you choose to define that.•

__________

Hahn is a certified financial planner and owner of WWA Planning and Investments in Columbus. She can be reached at 812-379-1120 or jalene@wwafp.com.