The Life Cycle Model of Saving

The life cycle model can guide your saving plan

The life cycle model of saving is a model that divides your life into cycles. The idea is that saving in one cycle gives you something to spend in another and vice versa. You can use this model to plan your retirement.

Early Years

In the first stage of your life cycle, when you are just starting your career, your earnings are not high. However, you have a long time left in your life cycle and your medical expenses are low. What's more, odds are you will earn more later. Therefore, you don't really need to save a large amount---the next phase of your life cycle will be able to take care of itself.

This is not, of course, an invitation to get into enormous debt because you will be passing those costs onto your middle-aged life cycle.

Prime Earning Years

The middle of your life cycle is your prime earning years. Health-related costs tend to be low and income tends to be relatively high. These years are prime years to save---your income is high, and your obligations to the next phase are equally high. Not only should you save, but you can afford it.

Retirement Years

The retirement years are when your income is low (or zero) and your consumption is high--particularly of health care. Since there is no phase after this, you don't really need to save during it. However, you should have saved prior to it, thus turning the savings of your middle phase into income during your retirement phase.

References

• Federal Reserve Bank of Boston: The Theory of Life Cycle Saving and Investing