In 1985, an MIT professor won the Nobel Prize for a simple technique that squirrels know intuitively from birth — you have to “squirrel” away some nuts during times of plenty so you can survive during times of scarcity. Economist Franco Modigliani won his Nobel Prize for modeling how humans manage their household finances over a lifetime.

Modigliani looked at the income and expenses of typical people over their life from the time they entered the workplace, raised their families, and retired. He found there were times when the household’s income was more than sufficient to meet their expenses and other times when money was tight. Preparation during these times of surplus helped families avoid going into debt during times that required increased spending.

There are four distinct phases in a household’s financial life cycle:

1. Pre-child surplus of income

2. Child raising & education income deficit

3. Post-child income surplus

4. Retirement small surplus

Two periods of this life cycle have surpluses. Saving during these periods is crucial to financial well-being later in life.

Pre-Child Surplus of Income

Early in your career, when the cost of basic needs is small, income often abundantly covers expenses allowing the surplus to be used for savings, investment or added consumption. Many young people make the mistake of assuming that they are doing so well financially that they can simply spend their extra money on added consumption. They might not account for higher spending while they are raising children.

Child Raising and Education Income Deficit

Those who have raised a family know how expenses multiply once you have children. The one-bedroom apartment is replaced by a four-bedroom home with a mortgage. If expenses for food, clothing, medicine, dental care, sports, camps, and lessons aren’t enough, children have their own set of endless marginal desires! In total, the average cost of raising a child to age 18 in current dollars is about $250,000. After a quarter of a million dollars in payments, the balloon payment for children comes at the end when college expenses are often financed through student loans and additional mortgages. During these years many couples wish they had not spent their pre-child surplus.

Post-Child Income Surplus

For most families, expenses drop significantly after their children are through college and out on their own. Although it is ideal to start earlier, these are the years when many families realize that they only have several more years to prepare for their retirement and they seek professional financial advice. This period provides a second chance to save and provide for a financially secure retirement.

Even when you are about to retire, there is still time for your assets to grow.

Retirement Small Surplus

Retirement hopefully finds the family with income adequate to continue their usual lifestyle. With sufficient assets and good asset management, income from savings and investments, pensions and benefits should cover their retirement expenses.

The lessons to learn from Modigliani’s work are simple: before the children arrive, squirrel away some money. When the children go out on their own, you get one last chance to save for retirement!

The original version of this article was published August 4, 2003. Photo by Good Free Photos on Unsplash