Alrighty, here we are, back again, to continue the awesome journey that is “financial planning”. In our last post, you figured out two key pieces of information: where you are now and how much your “savings rate” is(or how much you can save each year). Do not be afraid if you feel like you don’t have much to start with, or if your savings rate is low. The fact that you are doing this process puts you about 7.4 steps ahead of most Americans. This part of the process involves figuring how and where to apply and invest that savings rate, to help you reach your goals.
Wait, “What goals?” you might be asking…
Good Question! We have to make those up! This is why it is the “fun” part of the process. Now, in the traditional financial planning process, we typically assign specific values to your goals (e.g. I want to live on $50,000 a year, indexed for inflation, starting when I turn 62, with an assumed tax rate of XX% and an assumed annual return of Y% with a standard deviation of Z) and use those variables to calculate exactly how much you need to save, including your starting point, each year, to reach that goal.
But that is basically just boring math (unless you are a dork like me) and not fun. So if you want to have a very SPECIFIC goal, I suggest you find a competent planner and have them run that calculation. Unless you want to take a college course on the time value of money and finance equations in which case, go nuts!
In our process, we start much more simply. I want to encourage you to stick to your budget and save as MUCH as you can. If we calculate a number and you can’t hit that, you might get disillusioned and give up, which will put you in a much WORSE position. This is why I like to use the “Bucket” method. I did not invent this, it isn’t “my” method of planning, a lot of great planners across the country use this model or something very similar. The basic idea is this:
You have competing goals, with different time horizons and different risk tolerances, therefore, you need different investment strategies for each goal.
Make sense? If you are 30 years old, how you invest for the house you want to buy (two years away) will be different than how you invest for your new baby’s college education (18 years away) which is different than how you invest for retirement (35 years away). In addition to time horizons, you also have to deal with the complexity of tax-deferred or non-tax deferred accounts.
But we will get to that later. For now, you need to start making “Buckets”. I have about 10 buckets that most clients use (they rarely use all of them) so look at this list and see which ones make sense for you:
This one is mandatory and belongs in EVERY financial plan. It is also the FIRST goal to be funded. It should always be in a 100% liquid FDIC insured account.
This bucket is pretty self explanatory. It is designed to fund an education goal. Typically for your child, but I have also used this bucket for people that want to go back to school.
This bucket is used if you are saving for a specific goal. It might be something large like a vacation house, a boat, or other expensive fun items. It can also be used for smaller items, like the annual family vacation, a new TV, or a swimming pool (yes, these are all things I have helped clients make buckets for). You can also have several of these buckets.
This is one of my favorite buckets and one that people tend to like as well but never really think of. This bucket is designed to be an added layer of usable capital, but earns more than your emergency fund, which is only ever in a savings account. The goal is that it is invested to beat inflation by 1% or so, but you will never have more than a 10% down-swing. So if you need the money you never have to say “I can’t sell now, the market is down so much!” I would use this bucket a lot if you have a small business and want additional backstop on the business, or if you are thinking of starting another business, or expanding yours, anything that you might be saving for but that may not be a certainty.
Long Term Growth
This bucket (which is typically for retirement, but not always) is where the “gambling” money goes. It has the highest risk tolerance and the longest time horizon. This is typically where tax-deferred accounts go because we cannot access them until we are 60 years old. For folks that are already retired (70s or later), or have a high net-worth, I will refer to this as the “Legacy” bucket. These are funds that they basically do not need in their lifetime, so we are investing it based on the heirs’ needs and situations.
I typically use two buckets for retirement, because retirement is the BIG deal in financial planning and is also one of the most complex pieces of financial planning. Transitioning from accumulating wealth to living off of it can be a very scary and difficult thing to do. These buckets will differ from the ones above because they will typically be designed around producing income as their primary goal. In addition to the two buckets below, you will often still have several of the buckets above (like Stable Vale or Long-Term Growth). But these are the two that are typically specific to retirement:
This is the bucket that pays us a “pension”. It is an income stream that has some sort of guarantee on it, so we know that our basic bills are paid, no matter what. If you happen to work for the Government (or you work for a Fortune 500 Company and it is the 20th Century, not the 21st) you probably already have this bucket funded with your pension plan. But most people don’t and they need a steady income stream to rely on.
Growth & Income
This bucket is the one that is used to fund “lifestyle” expenses. All that traveling you want to do, the hobbies you want to pursue, all that good retirementy (yes, retirementy is a technical term in financial planning. Trust me, I’m a professional) type stuff. Unlike the Guaranteed Income Bucket, this income stream can go up and down, which is why we only use it to fund the expenses that could get cut out if we needed too. It is also designed (later in retirement) to combat the inflation risk that will be inherent in most Guaranteed Income Bucket investments.
I was going to start talking about how to fund these buckets and in what order, and what percentages should go into each one, but I just realized I have been typing for a long a time and HOLY COW this post is already 1200 words, so this is where I will leave you for now. Think about these buckets and which goals you think are critical for this stage in your life. Tune in next time and I will help you pick those buckets and guide you on how to fund them.
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