August 14, 2023

Even if you’re new to investing, you might already be familiar with some of the most basic principles of investing wisely. How did you learn them? You can learn about the stock market through real-life experiences that have nothing to do with the stock market.

Take for example street vendors who sell umbrellas and sunglasses. Have you ever noticed how these items seem unrelated? Initially, that may seem odd. A person would only buy both items at the same time if they were needed. Probably never – and that’s the point.

Due to the increased likelihood of customers needing umbrellas, street vendors see rain as an opportunity to make more sales. On the other hand, vendors recognize that fewer people are likely to buy sunglasses on rainy days.

And when it’s sunny, the reverse is true. The vendor can make more money by selling two different items instead of just one. This way, even if one of the items doesn’t sell well, they might make up for it with the other item.

If you understand what asset allocation and diversification mean, then you have a good foundation for investing. The topics to be covered in this article in more depth are: the importance of rebalancing your investment portfolio from time to time, and how to do so.

The Bucket Plan involves allocating your assets into different “buckets” based on when you plan to spend them.

“Bucketing” Begins

The bucket approach to retirement investing is a way to combat the challenge of low interest rates that was first developed in the 1980s by financial planning expert Harold Evensky.

Many retirees have been forced to delay their retirement, reduce their standard of living, or take too many risks with their capital because the income from their investments has not been enough. Evensky built his strategy around three distinct buckets:

Bucket 1

This refers to living expenses that are not covered by other sources of income, such as a job, over the course of a year or more. An emergency fund can help you cover unanticipated expenses.

Bucket 2

This bucket should contain five or more years’ worth of living expenses, with income distributions from dividend-paying equities going toward the refill of this bucket.

Bucket 3

This bucket has more volatile, higher-earning products that can ride out a down market because the retiree does not need accessing this bucket for living expenses.

The idea of putting things into buckets became more popular during the 1990s, then increased even more when the time of the internet began.

Bucket 3 was a safe investment during the Great Recession in 2008. The money in Bucket 1 was being withdrawn and reloaded into Bucket 2 without affecting Bucket 3.

Setting long-term goals for Bucket 3 helped the retiree stay calm during market fluctuations and not lose money by cashing in during a downturn.

The Bucket Plan has been adapted to not just facilitate retirement income planning but to also be a viable strategy for asset allocation for all clients in any demographic.

The Bucket Plan Philosophy

Bucket plans provide peace of mind for your clients.

The bucket plan approach to financial planning is a simple but effective way to communicate your investment strategy to your clients. This process can be complex, but using this approach can help you explain your plan in a way that is easy for your clients to understand.

The key to a successful bucket plan is to strategically position a mutually agreed-upon portion of your client’s assets in order to buy a time horizon that allows them to invest the remainder for long-term growth.

The structure will give them a dependable way to make money during their retirement. Here’s how the buckets are constructed:

Now Bucket

Your client always has easy access to their money with this safe and liquid option.

If your client’s Now bucket is fully funded, they will feel secure and won’t have to sell investments for cash when they need money. This would also expose them to losses if the market declines, unexpected taxes, and penalties.

Although there is not much money to be made from the Now bucket funds, it is a small price to pay for your client’s peace of mind. The Now bucket is set up for free main situations:

Emergency or comfort fund for unplanned expenses

Some of the major expenses that people plan for are buying a new car, getting married, and paying for college tuition.

Up to one year’s income for a retired client

How much an individual puts into their Now bucket depends on their needs. Your client should have enough money to meet their daily needs or any emergency expenses, but not so much that they’ll miss out on potential growth for that money.

There are several dangers in both scenarios. Everyone involved should come to an agreement about how much money should be put into the Now bucket and feel confident that their future needs and expenses will be covered.

Soon Bucket

The Sooner bucket is the conservative investments or income money that can be used as a planned income source for the first phase of retirement.

The portfolio is designed to grow at a rate that offsets inflation, but it is invested conservatively to avoid the negative effects of a large market correction or downturn. This way, your clients’ income or spending plans will not be impacted by the full swings of the stock market.

This money has been protected from market risk (stocks), interest rate risk (bonds), or sequence of returns risk, meaning that your client will not have to sell at a low price if they need the money for income withdrawals.

The Soom bucket can help protect your client against inflation by providing extra money as the cost of goods and services increase. Pairing the Now bucket with the Soon bucket gives your client a time horizon to ride out market highs and lows without touching their investments in the Later bucket.

It helps them avoid the risk of losing money if they need to access their assets. For clients that plan to retire soon, the Soon bucket might be a good place to invest their money.

This means that if a good investment opportunity, such as starting a business or buying a new home, becomes available, they will have the money required.

This text is discussing the “Soon bucket” which is a reliable income for a client who is approaching or in retirement. The income from the Soon bucket will pour into the “Now bucket” which is for everyday spending. There are three primary ways of structuring income from the Soon bucket:

The bridge approach

You use a minimal amount of assets to construct a bridge, which provides reliable income for a specific period.

A 10 year bond, CD ladder, annuity, or conservative investment portfolio are all examples of conservative investments in which you will be consuming both principle and interest.

Lifetime income

You fund an annuity to provide lifetime guaranteed income. There are several ways to provide income during retirement, including buying a single premium immediate annuity, a deferred income annuity, a fixed annuity, an indexed annuity, or a variable annuity.

We would consider an annuity payment that is going to begin within 10 years to be a “Soon bucket” asset. We would place an asset in the “Later bucket” if we expect the deferral to be 10+ years.

Portfolio yield

Some high net-worth clients have enough money that they don’t need to use any of the original investment for retirement income, and can instead live off money earned from dividends, interest, or yield on the investment.

In some cases, it might be best to use a combination of these approaches.

Later Bucket

The money in the Later bucket is for long-term growth and legacy planning.

The client can feel secure about their retirement plans despite market changes because they have saved enough money to last them the first decade or so of retirement.

If people can wait a long time before accessing the “Later” bucket, they will probably get better results. In addition to growth, the Later bucket also includes legacy planning.

While it is true that some people use legacy planning as a way to pass on money to their children, it is not the only reason to do this type of planning. It is important to consider the needs of the surviving spouse when Legacy planning.

The loss of one spouse’s income usually leads to a decrease in the overall household income, as well as increased expenses in areas such as mortgage and utility payments, while taxes may also increase. The Later bucket lets you create a plan to help protect your spouse if you die first.

Asset Allocation Importance

An investor can mediate potential losses by creating a portfolio with diverse asset categories that will each react differently to changes in the market. In the past, the three main asset categories have not increased or decreased in value at the same time.

Returns on one asset are often based on the market conditions of another asset. When one asset is doing well, the conditions are usually average or poor for the other asset.

When you spread your investment among different asset types, you minimize the chance of taking a loss, and your portfolio’s ROI will be less volatile.

If the return on one asset falls, you can offset the loss with a higher return on another asset.

The Magic of Diversification

This technique is called diversification, and it’s used to lower the overall risk by investing in a variety of different securities. If you are strategic about the types of investments you make, you can minimize your losses and stabilize your investment returns without giving up too much potential profit.

It is important to consider asset allocation when planning your investments as it can have a significant impact on whether you reach your financial goals. If you don’t invest in riskier ventures, you may not make enough money to reach your financial goals.

If you are saving for a long-term goal, such as retirement or college, you will likely need to include at least some stock or stock mutual funds in your portfolio. This is according to most financial experts.

If you don’t manage your risk properly, you may not have enough money to achieve your goals.

If you are saving for a short-term goal, such as a family vacation, you should not have a portfolio that is heavily weighted in stocks or stock mutual funds.

How to Get Started

Determining the best mix of assets to reach a financial goal is complicated. Your goal is to choose a combination of assets that is most likely to help you reach your goal while also being an acceptable level of risk for you.

As you approach your investment goal, you may need to rebalance your investment mix.

You may be able to create your own asset allocation model if you understand your time horizon and risk tolerance and have some experience investing.

There are many different opinions on how to invest, and you can find a lot of helpful information online. Try to find reputable sources that can offer you guidance on making the best decision for your money.

Although the SEC cannot endorse any particular formula or methodology, the Iowa Public Employees Retirement System offers an online asset allocation calculator. You will be making a choice that is very personal.

There is no one-size-fits-all asset allocation model. The one that is right for you is the one you’ll need to use.

Some financial experts believe that your asset allocation is more important than the individual investments you buy.

You may want to consider asking a financial professional to help you determine your initial asset allocation and suggest adjustments for the future. This way, you can be sure that your portfolio is well balanced and that you are on track to reach your financial goals.

Before hiring anyone to help with important decisions, make sure to check their credentials and disciplinary history.

The Connection Between Asset Allocation and Diversification

Diversification is a strategy that is well summarized by the saying “don’t put all your eggs in one basket.” This means that you should not invest all of your money in one thing.

The strategy involved investing your money in different places so that if one investment doesn’t do well, the other investments will make up for the loss.

Many investors choose to spread their investments out among different asset categories in order to diversify their portfolio. But other investors deliberately do not.

For example, investing only in stocks could be a reasonable asset allocation strategy for a twenty-five year-old investing for retirement. Or, investing only in cash equivalents could be a reasonable asset allocation strategy for a family saving for a down payment on a house.

However, neither of these strategies tries to reduce risk by investing in different asset categories. An asset allocation model will not automatically diversify your portfolio.

Your portfolio is diversified if you spread the money among different types of investments.

Diversification 101

A diversified portfolio should be diversified at two levels: between asset categories and within asset categories.

You will also need to invest in different types of assets within each category in order to diversify your investment.

The key is to find investments for each asset category that will do well in different market conditions.

To diversify your investments, you can invest in a variety of companies and industries. Your investment portfolio will not be diversified if you only invest in four or five individual stocks.

In order to create a well-rounded investment portfolio, you should have a minimum of twelve different stocks.

Although a mutual fund investment offers the potential for diversification, it is important to keep in mind that this may not happen immediately, especially if the fund specializes in a single industry sector.

If you invest only in mutual funds that are focused on a single asset, you may need to invest in more than one to get the desired level of diversification.

Within each asset category, you may want to consider multiple options, like large company stock funds as well as small company and international stock funds.

When thinking about which asset categories to invest in, consider options like stock funds, bond funds, and money market funds. The more investments you add to your portfolio, the more likely it is that you will have to pay additional fees and expenses, which will reduce your investment returns.

These costs need to be taken into account when deciding how best to diverse your portfolio.

About the Author Brian Richards

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