Let’s Talk Buckets. #FinancialFitness2018
That’s a hard no.
When we think of “saving money”, what does that really mean? What are we saving it for? Emergencies is definitely one of them. What if you lost your job tomorrow?
But wait, what about credit card debt or student loan debt? Now that you have extra money at the end of the month, should you be paying that debt off?
And then you’ve got longer term goals too. Maybe getting a new car, or buying a bigger house. How much should you be putting towards those goals? And then, of course, there’s retirement. How much money do you need to save so you can retire when you want to?
All of these things constitute “saving money”. The real question is, what can you do to make sure that when you save money, it is helping you to reach these different goals in a logical and strategic way?
Enter “The Bucket Strategy”!
The Bucket Strategy takes your savings and breaks it up into different time horizons. In its simplest form, you have short term, mid term and long term buckets. The short term bucket is your emergency savings, the mid term bucket is money that you’ll need access to in the future but won’t need immediately, and the long term bucket is your retirement.
For many of my clients I add a fourth bucket; credit card debt. Credit card debt is something affecting people across the country, and the Bucket Strategy provides an option for resolving it.
So, how does it work?
Let’s say you have $200 at the end of every month that you could save. Instead of taking all of that $200 and putting it into one “bucket”, you break it up. For example, $60 could go towards credit card debt, $85 could go in the emergency savings bucket, $30 would go in the mid term bucket and $25 is put into a retirement account.
When you break it up this way, you’re putting yourself in the best position to meet all of your goals. You definitely need to be paying off that credit card debt, but you also need liquidity in the case of an emergency. Saving for retirement is incredibly important, because that is something we’re heading towards no matter what, and you need to have money saved for when you get there.
The next step is figuring out how to take these figurative buckets and put them into action. There are essentially two different types of accounts; non-qualified and qualified. Non-qualified accounts include checking and savings accounts at the bank or credit union, and individual or joint accounts with an investment firm. The capital gains and earnings on these types of accounts are taxable.
Qualified accounts are retirement accounts, including 401ks, IRAs, 403(b)s, 457s, etc. These accounts are tax deferred, meaning you pay taxes on the assets when you take them out (with the exception of a Roth IRA, but we’ll leave that out for now).
We can use these two different types of accounts as tools for the Bucket Strategy.
For the short term bucket, a non-qualified checking or savings account is typically the most appropriate. Because you might need access to these funds at any given moment, we typically recommend that they be kept in cash, and not invested in the stock market. For me, my goal is to have 6 months worth of income saved in this bucket. You’ll keep this bucket with your bank or credit union.
Your next bucket, the mid-term bucket, are funds that you are planning on having access to in several years. For me, the time horizon for this bucket is about 10 – 15 years. This can be different for everyone. The reasoning behind the mid term bucket is, I don’t need access to the cash now, but I also want to be able to have access to it in the future should I need it. Because I want to have access to the funds, I should keep it in a taxable account. I shouldn’t put it into a retirement account because my ability to access the funds is limited. If I were to try to take an early distribution from a retirement account, I would have to pay a 10% tax penalty on the withdrawal. So, non-qualified account it is!
For this bucket, I opened an individual brokerage account, where I can buy stocks, bonds and mutual funds. This allows me to invest money in the stock market. While I kept the short term bucket in cash because I might need access to it soon, I don’t need to access the funds in my mid term bucket for several years. Because of this, I was able to take more risk. I selected investments based on my risk tolerance, which is different for everyone.
The last bucket is the long term bucket, or the retirement bucket. This is when I would use one of the qualified accounts. You might have one available through your employer, or we could open one for you. In this account too, you would likely invest in the stock market. For most of our clients, because this is the money that you won’t need access to for a long time, you are able to be the most aggressive with your investments. Again, this is different for everyone. I don’t have access to an employer sponsored plan, so I opened an IRA, or Individual Retirement Account, for myself.
Those are all my buckets! Some of our clients have more than three buckets. They break their savings into a variety of future needs, including saving for a vacation, home renovations or a new car. Other clients have a debt bucket, to start paying off their credit cards in a manageable way.The important thing is to make sure you’re funding all of your buckets, and then to invest the money appropriately depending on how long it is until you need access to the funds.
Now that you understand what the Bucket Strategy is, and how to structure the different buckets, you have to implement it. The first step is to determine how much you want to go into each bucket. This will be different for everyone. If you’d like assistance in figuring out how best to allocate your savings, let us know! The second step is to get the money invested appropriately. For myself, I have set it up to happen automatically. I filled out paperwork with Pershing and Calvert to automatically deduct money from my account on a monthly basis, and I invest it according to my risk tolerance. And, voila! The bucket strategy is at work.
Please reach out to us if you need any help figuring out how to implement the bucket strategy. Sue, Gayle and I are available to help whenever you need it.
#FinancialFitness2018 #FinancialPlanning #Saving #BucketStrategy