I’m continuing the theme of inanimate objects being used as parallels for your financial planning. I personally prefer the milestones method of savings, but the bucket method works just as well if it makes more sense to you!
Many people are familiar with using buckets as a method for retirement income planning. It’s a simple strategy for managing money over a multi-year period, and helps you to apply an appropriate asset allocation for money you will need in a few months, a few years, in 10 years or more. Here’s how it generally works:
- Bucket 1: This bucket typically holds one to two years’ worth of living expenses, invested in traditionally more stable vehicles such as cash, certificates of deposit, money-market funds or short-term Treasury bonds. Putting money you plan to spend soon into liquid, generally low-volatility investments can help you avoid having to sell riskier investments, such as stock, in a down market to raise cash for living expenses. This bucket should be refilled annually.
- Bucket 2: This typically holds money that you expect to need within three to 10 years, invested in intermediate-term assets with a focus on growth and capital preservation.
- Bucket 3: This bucket typically holds money that you expect to need in 10 years or later, invested for growth and income.
There are lots of other ways to use buckets, depending on your life stage. If you’re in your 20s, consider one bucket for your emergency fund, another earmarked for a house down payment in a few years and a third invested for retirement. As you move through life, buckets can be used to save money for a child’s college tuition, a new car or a once-in-a-lifetime vacation.
Even retirement accounts can be invested in multiple ways. For example, some investors have opened separate IRAs—one for their personal use, invested based on their risk tolerance and investing timeframe, and the other for their children to inherit, which may be invested more aggressively to suit a longer timeframe and higher risk tolerance.
Which method do you use? Are you a milestones person or are you using the bucket strategy? Let me know!