As a society, we tend to overcomplicate things. If there is one thing we like to overcomplicate, it is our finances. However, it is possible to simplify the big picture of one’s finances and the various categories by thinking of your financial picture as “buckets” of money.
One of the founders of our firm and current Partner, Wayne Harris, has advised clients on the buckets approach for years. This is an analogy that everyone immediately understands, and many clients frequently refer to their accounts in these same terms for years after. So, let’s take a look at these buckets.
The first bucket is your cash/emergency fund. No matter the year, cash is king, and cash is comfort. There are plenty of textbook answers to how much money a person should have in cash and how easily they can access it, however, in our experience, the true answer to that question is what number helps you sleep at night. Turbulent times, like this year and in years past, have caused that “comfort number” to become higher and higher. Whatever the case, you cannot put a price on peace of mind, so the cash bucket is crucial.
Next, notice the retirement bucket on the right. This is another familiar bucket for many of us. One way or another, most people have heard of a 401(k), an IRA, or a Roth IRA. You are putting money here for the “future-you” to benefit from, so it should be left alone until you retire. There are various tax incentives and possible employer matching potential, but the retirement bucket’s main financial purpose is to be there for when you become financially independent and no longer need to work unless you want to.
The middle bucket is often the most overlooked but can be extremely important if structured correctly. Many will instinctively put money in the bank because that seems logical. Others will contribute to retirement accounts because these plans are often available through their employers and have tax benefits. The middle bucket, consisting of your investment dollars that are in no way tied to a retirement account, is a critical piece to the personal financial puzzle. If the first bucket is for the now and the third is for down the road, the middle bucket is for everything in-between.
Once you have established an emergency fund with your comfort level of cash, your money, in excess of bucket one cash, can then be invested within the limits of your personal risk tolerance for risk and return. While the main idea of this middle bucket is accumulation, you are also creating a portion of your net worth that you can access at any point without penalty. Once you have set aside an amount that reaches your comfort level, the middle bucket is where you can go for more substantial purchases. By having this money available, you can cover larger expenses (new car or big vacation) and make deposits to refill this bucket over time – “Pay yourself back” if you will. The middle “bucket” is an incredible tool, allowing one to save for life events while also allowing money to be working in between those events rather than being stagnant.
Three buckets. Simple, right? Ultimately, your goal should be contributing to each of these buckets consistently. You may notice that these buckets have spigots. The point of accumulating in these buckets is not for it to remain there, but to spend and enjoy your life! By filling up all three of these buckets appropriately, you can be advised on how to distribute based on the situation and time in your life. Need help deciding which bucket to fill first? Reach out to a Bridgeworth Advisor.