Seven Buckets of Money
Asset allocation is the cornerstone for helping guide clients to an enjoyable and prosperous retirement. With so many investment options and an increasingly volatile equity and bond market, it can be difficult to determine what asset classes are best for clients to invest in. Of course, there are many additional considerations to be made, but two of the most important concerns that must be addressed when allocating capital are an investor’s risk tolerance and their income needs post-retirement. One of my favorite ways to ensure a client has the funds necessary in retirement is by creating different tranches of money, or buckets as I like to call them, that each serves its unique purpose within an investor’s entire portfolio.
Let’s say hypothetically a couple is in their mid-fifties and wants to retire at age 65. The couple has done well financially and has a large cash position in a low-interest savings account, one that generates a negligible amount of interest income for the couple. This couple would be well served to consider deploying this cash into the following investment options, ordered from most conservative to most aggressive:
- Bucket one: The cash management bucket. Investments in this bucket will be allocated to cash equivalents like FDIC-insured CD’s and money market funds. This bucket will protect the investors capital while creating more interest income than if the money were left to sit in the savings account.
- Bucket two: A silver lining to the Federal Reserve raising interest rates is the higher yields investors can achieve on fixed-income investments such as US Treasuries. Treasuries have traditionally been viewed as the safest of all fixed-income investment options.
- Bucket three: A seldom used investment option; this bucket could contain a fixed annuity. An annuity is essentially a certificate of deposit with insurance wrapped around it. Additionally, many annuities offer penalty-free capital withdraws, making this a prudent way to protect capital and achieve a modest return while maintaining some degree of liquidity.
- Bucket four: Still classified as fixed income, municipal bonds and municipal bond funds offer investors federally tax-exempt income. One advantage of a fund versus induvial bonds is the daily liquidity provided by fund managers.
- Bucket five: Now on the equity side of things, preferred stock not only offers consistent income but also provides an opportunity for capital appreciation. In the hierarchy of a company’s capital structure and payout at dissolution, preferred stock ranks behind bonds but ahead of common stock.
- Bucket six: A diverse portfolio of equities will be constructed in the sixth bucket. Depending on a client’s risk tolerance and income needs, the portfolio can be designed to achieve income through dividend-paying stocks or can be geared more toward capital appreciation.
- Bucket seven: If the investor has an existing 401(k), it makes sense to allocate these funds in a more aggressive nature than the rest of the portfolio given the tax advantages offered in a qualified account.
In Summary, this seven-bucket plan provides you with a Cash management strategy in the first Bucket, a second Cash management strategy by buying the U.S. treasury in second Bucket, and an insured investment in the third Bucket. A tax-free approach with Municipal holdings in the fourth bucket, another income strategy in Preferred Stocks in the firth Bucket, a chance to outpace inflation with dividend-paying stocks in the sixth Bucket, and lastly, an opportunity to have a long-term growth strategy with your 401k in the seventh Bucket.
DISCLOSURES
Regarding money market funds (Fund), you could lose money by investing in the Fund. Because the share price of the Fund will fluctuate, when you sell your shares, they may be worth more or less than what you originally paid for them. The fund may impose a fee upon sale of your shares or may temporarily suspend your ability to sell shares if the Fund’s liquidity falls below required minimums because of market conditions or other factors. An investment in the Fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. The Fund’s sponsor has no legal obligation to provide financial support to the Fund, and you should not expect that the sponsor will provide financial support to the Fund at any time.
Some of the potential risks associated with fixed-income investments include call risk, reinvestment risk, interest rate risk, credit risk, default risk, liquidity risk, and inflation risk. Additionally, it is important that an investor is familiar with the inverse relationship between a bond’s price and its yield. Bond prices will fall as interest rates rise and vice versa. Municipal securities investments are not appropriate for all investors, especially those taxed at lower rates.
This information is intended to serve as general information. The results are neither guarantees nor projections, and any interest rate assumptions, rates of return, inflation figures, and other costs or figures are hypothetical and for illustrative purposes only. This analysis is hypothetical and no guarantees are made as to your ability actually to achieve these results. Market conditions, changes in tax laws or other unforeseen events could drastically alter the results. It is important to review your financial plan with your advisor on a regular basis. There is no solicitation and no recommendation for any action based upon its findings. The results of an analysis may differ significantly depending on the facts assumed. Dividends are not guaranteed, and past performance is not indicative of future results and are not to be taken as guaranteed projections of actual returns from any recommended investment opportunity. All investments carry some level of risk, including loss of principal and diversification does not ensure a profit or protect against loss. An investment cannot be made directly in an index.
Robert W. Baird & Co. Incorporated does not offer tax or legal advice.