Three Buckets: Saving & Spending
Saving for financial goals involves two phases: accumulation and withdrawal. These phases form the basis of a strategy to allocate savings and securities into different forms based on the time when the money might be needed.
One of the biggest concerns we hear about as financial planners is how, when and where to take money from savings and investments in retirement. We develop what we call a Withdrawal Plan and we usually develop it ideally about three years in advance of retirement to focus on cash funding budget needs. Then we periodically look at the withdrawal plan right up to retirement time and beyond.
What do we focus on? Cash to fund budget needs. What helps us paint the picture for our clients? We use an illustration the explains the Three-Bucket Approach. This approach is a strategy developed more than 20 years ago by financial planning guru Harold Evensky. It’s a timeline-based system to allocate savings and investments based upon when the money may be needed.
The Three Buckets approach divides savings and investments into a short-term (now), medium-term (pretty soon) and a long-term (later on) system for accounts that are both taxable and not taxed yet (or Roth not taxed after age 59 ½) retirement accounts.
Bucket 1 contains needed monies for the next couple of years and for emergencies. This bucket includes cash, insured savings, insured money market, and CDs.
Bucket 2 contains mostly fixed-income funds that produce a higher return while waiting to move to Bucket 1 when needed. It can also contain preferred stocks (or indexes) and longer-term CDs.
Bucket 3 contains equity (stock) funds and fixed income (bonds, CDs) securities in some allocation based on client risk tolerance described as aggressive, moderate or conservative.
Having enough cash to fund two to three years’ worth of budget needs can provide peace of mind, is easy to understand, and can adapt to changing needs.
On the other hand, investors using the Three-Bucket Approach have to be able to manage this approach or pay someone else to do it for them. This leads to additional costs and adding to the loss of performance because so much of their funds are in low-producing Bucket 1 securities. Multiple accounts also mean increased complexity for decision-making.
One of our goals as fee-only financial planners is to help clients develop and supervise their withdrawal plans. As one client said recently, “You’re helping me to sleep at night not worrying about the stock market.” Glad to be of service.
Want to learn more? Watch the webinar on Three Buckets.