Your investments are a means to an end. They’re not the end in itself. Your investments are just the tools you use to get the things you want (i.e., consumption goals). Since you’ll spend your money (accomplish those goals) over time, it makes sense to organize your investments to match the timing of those expenses.
Start With the Endgame
You should think about your investments with an eye on the future. What you have today and what you accumulate going forward, has to finance all the stuff that’ll define your lifestyle. So, start at the end and work backwards, kind of like reverse engineering.
Before you invest in anything, determine how you want to spend your money. That means articulating concrete consumption goals.
Those goals won’t materialize all at once. Some will happen sooner than others. So, figure out when each one will take place. Then, think about these separate time frames as being individual buckets.
Some things you’ll need the money for within a few months. Think of this as your short bucket. Other goals won’t be realized for years (midterm bucket). Many will take decades to accomplish (long-term bucket).
Now, apply an inflation rate to estimate the future cost of all these goals. This will give you a rough idea of how much money you’ll need to accomplish them and when that money needs to be available.
Set Goals and Rank Their Priority
After you establish the timing of your various consumption goals, rank their priority from high to low.
High priority goals are things you need. Think about your house. You need one and you can’t live without it. Your investments must finance this.
Low priority goals are the things you can live without. Ferrari? Maybe. Things like this may be financed by your investments…if there’s enough left over for them.
There will be plenty of other things in between the two.
But if you want to create a small pail for the Ferrari, there’s no harm in that! You can always spend that stash on something useful.
Financing Your Consumption Goals
Separating goals into buckets helps you determine how to finance them.
For imminent goals you might use short-term investments like CDs or Treasury bills. Those you expect to accomplish years or decades from now might be financed with long-term investments (think stock mutual funds or long-term bond funds).
A bucket strategy allows you to match the timing and priority of goals with the risk and return characteristics of different types of investments.
Typically, investment risk and return are closely related to each other. Investments with low risk generally provide low returns. Investments offering high returns often come with more risk. The same can be said of time.
Short-term investments typically have lower returns than investments that reach their full potential over long time periods.
So, high priority goals with short time horizons might be financed with short-term investments. Long-term, high-priority goals may be financed with long-term, high-return investments, even if it means taking on a little more risk.
What to do Next
One of the biggest buckets you’ll fill will finance retirement, so start experimenting with some what-if scenarios using our Retirement Planning Calculator.
Then, when you’re ready to put your bucket strategy into action, call us Monday-Friday 7:30am to 8:00pm (CT) at (800) 235-8396.