As we’ve covered throughout this years’ series of articles, 401(k)s are extremely useful tools to begin investing for your future. We’ve also stressed that a 401(k) cannot be the only tool in your toolbox for building your finances, nor should it be the first tool you pick up. In this brief article, we’d like to unpack a little more about how you can achieve balance with your money and investments.
Three Buckets, One Hose
To remain balanced and realize your full financial potential, Invst recommends using a “three bucket” system for your cash flow and savings.. Keep in mind that this using this system assumes you’re actually saving, ideally at a rate of at least 15% of your household income. You’re “pouring” money into these buckets with your systematic, regular savings; if you shut off the spigot – if you don’t consistently save – then you’ll run out of water.
Bucket One: liquid assets. It’s for emergencies; money that you can access easily to cover three to six months of expenses or unexpected items. This bucket needs to be filled first and remain constantly filled. If you need to dip into it, the you should redirect your next monthly savings back to this liquid bucket until its refilled to correct levels. Since this bucket is meant to be more liquid, investments here will need to be very conservative, such as simple savings accounts, short term bonds, life insurance cash values, etc.
Bucket Two: intermediate savings: 3-15 years out. This bucket is for a house, college, or other large expense that you won’t end up touching for at least three years. This is also a place to save towards additional investment or business opportunities. For people who want to accelerate and retire early, we focus on bucket two. With this account, it’s important to invest at a moderate level as compared with your longer-term savings. While we can still use growth focused investment vehicles, it’s important to temper the level of risk and, where possible, dial in that level of risk for the specific time line of the thing you’re saving towards.
Bucket Three: long-term savings bucket. These are the investments that will not be touched for at least 20 years — your 401(k), IRAs, etc. This is a bucket that, if you’re comfortable with it and it fits your Risk Profile, can be invested more aggressively. It’s crucial to always follow your Risk Profile so you are comfortable with your investment choices and opportunities, and then figure out the investment plan that works best for you here.
How to Split It:
If you consistently invest 15 percent of your income across these buckets, you will be setting yourself up for financial success; to eventually retire and live the life you want. However, it is very important to make sure the first bucket is completely full before beginning to fill the other buckets.
As a rule, when you have money to save, check the balance of Bucket One to make sure it’s at target levels (at least 3-6mos of expenses). If it is, you’re free to move on and sweep money into Buckets Two and Three. If it’s not, you need to pause your intermediate term & longer-term savings to rebuild Bucket One.
When you’ve got a green light with Bucket One, you can start dividing between your buckets evenly or in differing proportions to save towards specific opportunities or goals. One caveat, however: if you have a 401(k) plan which offers a company match, you should at least be saving enough into Bucket Three to earn the full match. This is the only free lunch in investing!
Equally important to saving a proper amount into a three-bucket strategy is to make sure the entire system is protected. Any good financial strategy is proactive with protection, and measures need to be taken to protect your assets, cash flow, and the people who are counting on you. The cost of protection items should be in addition to the 15% that you’re directing into your buckets. Ideally, you should be carrying full value coverage for: home, auto, life, disability and umbrella.
For example – let’s say you’re driving around a nice BMW and Susie-Q-Teenybopper slams into you at an intersection; she was busy texting her friends about something that was “OMG SMH!”. When they tell you your car is totaled, are you going to want another BMW or would you be ok if they replaced that with a Kia? You want the BMW, right? Well, in this case, we need to make sure that your car is protected for its full replacement value, because you know Susie-Q wasn’t insured.
This is just one example of an item on your balance sheet; your entire balance sheet and your cash flow system (read: your income) needs to be wrapped in protection for its full value.
Your financial life is so much more than just the money you put away for retirement. Kind of how life is about a lot more than just retirement, right? It’s equally about saving for different needs throughout your life, as well as protecting your different assets and retirement savings from accidents and unfortunate circumstances. If you’re not sure how to manage all of this, speak to a Invst advisor for some guidance and recommendations.