How to Use the ‘Bucket Investing Approach’
Knowing exactly how to save and invest is not easy.
Let’s say you need a new roof within the next 3 years…
What exactly should you do with savings and how do you invest it? In a bank account? Stocks?
And what about your 5-year-old’s college-fund that he will need when he is 18? Should it be invested the same way that your 401(k) is? Let’s talk about it.
Whenever I contemplate how to invest money, I ask the following questions:
1. What is the purpose of these particular dollars?
2. When will these dollars be needed?
If the money is likely to be used for an expense occurring within the next 1-4 years, I assign it to the Short-Term Bucket. 4-10 years is Mid-Term. Anything over 10 years is Long-Term. Each bucket should be invested differently.
Now, your Mid-Term Bucket might look different than someone else’s Mid-Term Bucket because of your risk tolerance. However, your own Mid-Term Bucket should be filled with investments that look different than what is in your Short-Term and Long-Term Buckets.
Let me describe The Bucket Investing Approach:
Bucket 1: Short-Term Needs (Conservative Investments)
The first bucket is designed to cover immediate expenses and cash needs over the next 1-4 years. The goal is to ensure your financial stability in the short term, which means prioritizing safety and liquidity over growth.
For this bucket, you’ll want to focus on conservative investments such as:
- Cash: Keeping a portion of your funds in a savings account or money market account ensures immediate access to cash when needed.
- Certificates of Deposit (CDs): These offer a slightly higher return than regular savings accounts while still being low-risk.
- Treasury Bills or Short-Term Bonds: Government-backed securities like T-bills provide safety with modest returns, making them a solid choice for this conservative bucket.
The purpose of this bucket is to ensure that even in the event of a market downturn, you won’t need to sell riskier assets at a loss to cover your living expenses.
Bucket 2: Mid-Term Needs (Balanced Investments)
Here, your investment approach should be a balance between growth and preservation of capital, aiming to outpace inflation without taking on excessive risk.
For the mid-term, consider these balanced investments:
- Balanced Mutual Funds or ETFs: These funds blend stocks and bonds, providing moderate growth potential with some level of downside protection.
- Corporate or Intermediate-Term Bonds: Bonds with a medium maturity can offer a balance of yield and security. Corporate bonds, in particular, provide slightly higher returns than government bonds but come with additional risk.
- Dividend-Paying Stocks: Quality companies with strong balance sheets and a history of paying dividends can offer income while maintaining potential for price appreciation.
This bucket serves to replenish the conservative bucket if it gets depleted, while still growing your assets at a moderate pace.
Bucket 3: Long-Term Growth (Aggressive Investments)
The purpose of this bucket is growth, as you won’t need to touch these funds for many years. This allows you to be more aggressive and take on higher risk, which historically results in higher returns.
Here are investments suited for the long-term bucket:
- Stocks: Owning a company through holding stock is an excellent and proven way to build wealth over time!
- Real Estate: Real estate can provide both appreciation and income over time. It is not my cup of tea, but it can be effective for those with tolerance and interest for it. It definitely belongs in the long-term bucket…. Not the short or mid-term!
- Equity Mutual Funds or ETFs: These funds focus on holding or tracking equities – with little exposure to bonds. They come with more volatility than their balanced counterparts.
By the time you need the assets in this bucket, they will have had years to appreciate, helping you fund later retirement years.
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There are thousands of investments in these categories, and you might need a professional’s help to select the specific securities most appropriate for you. You can bring valuable help to your advisor by making sure they understand the time horizon on your goals and dollars.
You might identify that you have too much cash in your short-term bucket that really needs to move to long term, because you don’t need it for the next 10 years.
Or – perhaps you realize you have been shoving all of your cash into growth stocks, when you should really have that pulled out of the market for short term needs.
In my opinion, getting your dollars assigned to the right buckets is the most important part of investing! The rest will fall into place with a little help.
