We talk a lot about ‘buckets’ in retirement. You’ve got your ‘bucket list’ which you want to accomplish before you ‘kick the bucket’. Let’s add one more to the list. There’s a ‘bucket’ strategy that allows you to spend and invest at the same time. It’s a concept that proves you can live comfortably today while you’re saving for your future retirement. Let me explain.
3 buckets of wealth
To achieve true financial security, you need 3 buckets of wealth. These buckets represent 3 pools which will allow you to fund your short-term, medium-term and long-term income needs.
First, you’d want a bucket for peace of mind to fund your day-to-day living costs. The second bucket will be for lifestyle wealth to pay for pre-retirement costs like a new car or a big holiday. Finally, if you want to have enough resources to fund your retirement, then you’d need a bucket for retirement wealth. Let’s take a look at how we decide how much and what to put in each bucket.
Peace of mind wealth
The first bucket focuses on your short-term goals which are generally up to 12 months. This is where you put sufficient funds to meet your day-to-day living expenses and emergency funds.
This portfolio will be cash-based to provide short-term security. This gives you peace of mind that you will have money to live on now and in the short term so if we do have a down market, you know that you have enough funds now to ride out those hard times. This is your safety bucket for immediate liquidity and to cover a small emergency.
To determine how much to put in this bucket, you need to draw up a budget to determine the amount required for your day-to-day living expenses; add cash required for short-term goals and then add a cash reserve amount for any emergency expenditures.
The second bucket is for medium to long-term goals before retirement. This includes lifestyle costs like upgrading the house, a big holiday or buying a new car. In this portfolio, you can afford to take a little bit of risk. Not too much risk, but enough to gain enough returns to beat inflation.
This portfolio may comprise of balanced style assets with a focus on yield. Like the first bucket, this is also a safety bucket but with a focus on future liquidity and can be called upon to top up the first bucket if required.
The amount to place in this bucket will likely change due to many variables like marriage, children, divorce, changing jobs or just a change of mind or priority. Consequently, the investments to use need to have reasonable liquidity.
This final bucket is something you’d be familiar with. The bulk of this portfolio is in superannuation and is designed for long-term investing. This bucket aims to hold your funds for life after employment.
This is the portfolio that will hold assets which can grow in capital value. Examples of growth assets are shares and property. Share growth occurs when companies reinvest part of their earnings to become bigger companies. The growth from property comes from increased demand for its use through rent.
The trade-off for this benefit is the increased risk; where the price of the asset can have more extreme moves. Shares can drop in value and so can property prices.
The amount of retirement wealth required will be determined by the amount of income you will need when you retire. The sooner you focus on this bucket, the more control and options you will have on the income you can have in retirement.
If you are not on track, you may need to settle for a lower level of income or be forced to work longer. Otherwise, you will run out of money. Remember, your retirement can last 20 or 30 years or longer and so this bucket will require a considerable level of assets with a potential for capital growth.
More control means more choice
The sooner you start planning, the more control you will have on your investments. The biggest benefit of planning is that you’re buying yourself time.
Investment planning involves more than just choosing products. First, you must establish your needs and goals (now and in the future). Then you need to determine how much risk you’re willing to tolerate.
After these steps are complete, an appropriate portfolio can be assembled to achieve the desired level of return with the least amount of risk, within the parameters that have been set.
This is where the 3 buckets come in. When wealth is divided in this way, it alleviates the confusion about where to take the money from when you need it.
You point. We drive.
You can do it yourself and create your buckets of wealth. Just be careful because you could fill your buckets incorrectly.
If you put too much in cash-based investments, you may neglect retirement wealth requirements which often require a much higher level of return to meet desired retirement income levels.
Or, investing entirely in property may neglect your liquidity requirements of peace of mind wealth.
Choosing an investment that made a lot of money in the past isn’t the way to go either, because there’s no guarantee it will continue doing so.
Remember, you’re in the driver’s seat. Your job is to point where you want to go. A financial adviser takes you there.