Most people's lives can be divided into three distinct stages: your education, which extends all the way from your first day at kindergarten to the day you walk across the stage to receive your college diploma; your working career, in which you accumulate most of your wealth; and your retirement years. Each stage of your life cycle critically affects the subsequent stages, and each contains unique risks that need to be effectively managed. However, no matter what stage you're in, the most important asset you have is yourself: your human capital and your earning potential.
TUTORIAL: Education Savings Account

Life Stages
The education stage is a very important stage for everyone. The path we take at this stage in our lives will affect not only our future earnings, but also the person that we become. In terms of earnings, there is a significant amount of studies that have been done that show a strong correlation between the level of education and the amount you earn over your lifetime. Although this is an important stage in your life, the risks faced in this stage are less significant than ones you face in the next two stages.

After the education stage, you move on to the working years of your life. At this point, your debt level is usually high, but your potential to earn income is also high. This potential to generate earnings comes solely from your own abilities, and is what many people refer to as your human capital. As you move along in this stage, you slowly begin to convert your human capital into financial assets, and it is at this point in which your human capital is at its most vulnerable. If there is a sudden loss of this ability to generate income, you and your family can become exposed to significant risk of financial hardship. (Professional maintenance can be a chore. Learn how to streamline the process. Read Keeping Up With Your Continuing Education.)

Next, after decades in the workforce and accumulating financial capital, you enter the last stage: retirement. At this juncture you start spending the money you've saved throughout your lifetime, and for the foreseeable future, your expenditures typically become greater than your income. Because no one can know when they are going to die, the biggest financial risk you face in this part of your life is that you outlive your financial assets.

The specific risks you face depend largely on the stage of the life-cycle you are in. The dominant risks faced during your life are becoming disabled or dying unexpectedly in the prime of your working life, and secondly, outliving your assets in your retirement years. Hedging these risks can give you and your family peace of mind.

Mortality Risk
Most people who have invested their savings into index funds or have their money professionally managed would consider themselves fairly well diversified, and their assets fairly protected. But are they really? Unfortunately, the answer is often "no." When looking at ways to protect your assets, many people overlook their most important and productive asset: themselves. The reason people diversify their stock portfolio is because if one company performs poorly, it will usually only have a small impact on their total portfolio. However, if you think of your portfolio in a total portfolio context that includes both your financial assets and your future earning potential as an asset, and then re-assess the impact of something adverse happening to you, you'll quickly realize how undiversified you actually are. Your disability, or worse, your mortality, would have a disastrous effect on the financial well-being of your family, especially if it occurs early in the working stage of your life.

Fortunately, from a financial perspective, the adverse effects of your death can be mitigated with a traditional life insurance policy. A life insurance policy will pay out a specified amount dependent on a certain event occurring. It works a lot like a stock option does, in that if a certain event occurs, your family will receive a lump sum, and it is this characteristic that makes life insurance the perfect hedge to this risk.

A term life insurance policy is generally preferred by people looking to protect themselves and their families for a specified "term." This is due to the smaller premiums charged for term life insurance compared to whole life, which makes it more affordable for many. In addition, term life insurance may be more attractive because if you've made it to retirement, the need to protect your income stream is significantly less and you can typically rely entirely on your accumulated savings from that point on. (Learn how much - if any - insurance you really need. Check out How Much Life Insurance Should You Carry?)

Longevity Risk
The risks of death or disability are significant, but even if you've made it to retirement, you're still not home free yet. The biggest fear that many retirees have at this stage of their life is whether or not they've saved enough money. No one wants to be in situation where they've lived longer than they anticipated and now find themselves unable to pay for basic utility or food bills.

The average age used by many financial advisors to plan for your retirement needs is generally around 85 years old. The problem with the 85 year target age is that a lot of people are living past that age because that number is simply an average. In addition, the standard of living in many developed countries continue to rise each year, and if you are reading this article far into the future, the average age could have risen significantly.

Ensuring that you don't become poverty stricken because you've had the fortune of living a long life is actually quite simple. A financial product known as a lifetime payout annuity can completely hedge the risk of running out of money in retirement by paying you a payment (annuity) every month until you or your spouse dies. It is a simple product that can have a profound impact on your quality of life, and which is why, if you're planning for retirement, it should play a critical role in your overall portfolio. (Added features can make a variable annuity suitable for certain investors. Find out if it could work for you. See Variable Annuities With Living Benefits: Worth The Fees?)

The Bottom Line
Traditional financial advisors preach diversification as a way to protect your assets, but many fail to recognize the need to diversify and protect your biggest asset: you. By recognizing this risk, you can consider hedging them easily with two simple financial products, life insurance and lifetime payout annuities, and have a truly diversified portfolio.

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