Your Personal CFO
The three-bucket approach is an investment strategy that utilizes strategic asset allocation. It is based on the idea that the risk of an investment changes depending on how soon you need access to those funds. Over the next couple of minutes, I’m going to explain the bucketing strategy, and the advantages it can bring to you as a smart, proactive investor.
If you look at all of the investments available on the market, things like cash, money market funds and short-term GICs carry little risk for an investor that needs money in the next year or two, but can be very risky for a longer-term investor. The low returns may not keep pace with inflation, or be enough to meet long-term retirement goals.
On the other hand, investing in equities can be quite risky for an investor with a short-term time horizon, but can provide excellent growth for patient investors willing to hold through periods of volatility. The hard part is trying to find that right balance between short-term safety and long-term growth.
Let’s take a look at an example. Say you are approaching retirement and you and your partner have a combined investment portfolio of $2,000,000. The annual income you estimate that is needed to maintain your lifestyle is approximately $100,000 per year and about 40% of that will be covered by the Canada Pension Plan and Old Age Security. This leaves a $60,000 gap that needs to be covered by withdrawing from your investment portfolio.
So, we know a withdrawal of about $60,000 per year is needed and we’re going to use the three-bucket strategy to help us do this. In the first bucket, you want to allocate enough cash to cover 1-2 years of withdrawals. Based on our example where you would need about $60,000 per year, you would want to have around $120,000 in pure cash and money market funds. The purpose is to provide safety, immediate liquidity, act as an emergency fund, and to have cash at the ready just in case any unique opportunities pop-up. You wont make very much interest, but this is where you will be pulling your money from in order to fund your spending in retirement.
The second bucket covers years 3-7 and you’ll want to allocate approximately $300,000. Here, you can start to look at medium term investments such as bonds and mortgage funds that will earn a slightly higher return. The goal is still to provide safety so you’re not looking to take on anything too risky here. You will be establishing means of future liquidity that will provide a buffer to your emergency fund and also provide cash that is reasonably available as opportunities arise. Interest earned will funnel back into bucket one helping to replenish that 1-2 year cash balance.
The third and final bucket is your long-term bucket. You want to allocate all remaining funds that you will not be needing for at least the next 7 years. Investments will focus primarily on equities, which have proven time and time again to be the best performing asset class over long-periods of time. The goal here is protection from inflation and long-term growth . Assuming you are properly diversified amongst high-quality companies, you will earn dividend income and the price of your stock holdings will increase overtime if you are strong enough to hold on during periods of volatility. Earnings and dividends will be available to flow back into your short-term bucket should you need to replenish your 1-2 year cash balance. It’s important to note all rate ranges shown are for illustration purposes only and that the return you make will depend on the individual investment’s that are selected within each bucket.
The key here with all of this is to implement this strategy and then re-focus on your life goals rather than focusing on your finances. Don’t sweat bumps along the road, your short-term bucket has your back during times of volatility and your medium and long-term buckets are there working towards your overarching financial goals.
With that being said, time is on your side, and the best time to start with a proactive financial plan is right now. Book an online financial consultation today to chat with an advisor about how you can implement the three-bucket approach into your own financial plan.
This is an informal meeting that gives us a chance to get to know each other. We do not charge for the initial consultation, which will take place online over a secure video call. The goal is for you to get comfortable with our team and lay the foundation for future conversations.
Constructing Your Financial Roadmap
Over subsequent phone and video calls, we discuss details and outline actionable steps to create the financial structure for your future. We review specific financial planning strategies, ensuring you are fully aware of your options. Our goal is to help you make the most informed decision for your financial future.
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This is when a mutual decision is made to work together or not. At this meeting we ensure all details are clarified and any questions are answered.
Implementing Your Advanced Plan
Over phone and email, our team ensures the proper documentation is addressed with identification and signatures. Once the administrative process of opening and transferring accounts is complete, we begin to implement the previously agreed upon solutions and strategies.
Changes to financial markets and changes in your life can often dictate updates to your plan. Regularly reviewing and evolving your plan ensures you have the best chance of success in the future.
Investment Strategy Creation
Investments like cash and short-term bonds carry little risk for an investor whose time horizon is short, but can be very risky for a longer-term investor. The low returns may not keep pace with inflation, or be enough to meet long-term goals. Stocks on the other hand, can be very risky for the short-term investor, but carry less risk for patient investors willing to hold through periods of volatility. Knowing how to properly deploy your capital in the right asset classes, based on your long-term goals and time horizon is key to optimizing your financial future.