How to Use the Bucket System to Manage Your Money

As financial advisors, our goal is to help our clients live a financially healthy and fruitful life through smart financial planning and investment advice. A time-tested strategy many investors use is called the “bucket” system, which, when implemented correctly, guarantees income in the short term while setting your longer term investments up for longer term success.

In this episode of Capital Conversations, CERTIFIED FINANCIAL PLANNER™ professional Colin Day and portfolio manager Ryan Potts talk about how to implement the bucket system in your finances. Whether you're in your 30s, approaching retirement, or anywhere in between, learn how the bucket system is an effective strategy to make your money work effectively over time.

For recent investment news and our take on the current market, retirement planning, and investment, listen to our podcast Capital Conversations or view our recent blog posts.

Below is the transcript for our most recent podcast, "How to Use the Bucket System to Manage Your Money."

Colin Day: Welcome back, everyone, to another Capital Conversation. I'm Colin Day, CERTIFIED FINANCIAL PLANNER™ professional. With me again, Ryan Potts. Ryan, you've been sitting in that seat for a while now.

Ryan Potts: I forgot to get up between clicks, so I cannot be on my feet right now.

Colin Day: We were joking if Ryan needed a change out of this vest, but I think we're okay. I think it's okay to acknowledge the fact that, “Hey, sometimes we have to put these podcasts together on the same day to make sure that we we do them [and] we get them out at the right time.”

But I thought it was interesting that we had you for a couple editions that we're doing for this particular month because of some of the things that you bring to the table as a portfolio manager. Like what we talked about in the previous podcast about Bitcoin and what we're going to talk about today, which is about budgeting, cash flow, and then maybe an approach for all this. There's a good metaphor for all this so that our listeners or viewers are able to conceptualize what we're talking about today.

So, does that sound fair?

Ryan Potts: Absolutely.

Colin Day: Okay. So, what we're going to talk about today is specific to those people that may be struggling to understand how their money might work for them over time. So, if you're watching this or listening to this and you're in your 30s, you're gonna have a different idea as to how your money might work for you, as opposed to somebody that's past the what-we-call accumulation phase and are now in a spending phase.

So you might be retired. And if you're retired, you might be thinking, how does my money work for the rest of my retirement? Or maybe you're somewhere in between there and you're thinking, man, “I really need to figure out how I might piecemeal this together so I can retire in 10 years, five years,” whatever it might be.

So an approach that financial advisors commonly use is called a bucketing approach. It means that we're putting certain amounts of money into different kinds of areas, accounts, buckets, so to speak, so that we can conceptualize how we might be spending in the future. So, Ryan, you know, we're going to call this a goals-based bucketing system.

So why don't you give us a little bit of the rundown of how you might explain that to somebody?

Ryan Potts: Yeah. Well, I want to take a step back first and say probably the most important driver of your returns as an investor is going to be asset allocation.

And really quickly, asset allocation is important because ultimately that's what's going to drive your portfolio returns. So as an investor, when we think of long term investing, 10 plus years out, we want to make sure that we're allocated in a way that's going to help us drive those returns higher.

The best way to do that sometimes is diversifying your investments, not only between stocks and bonds, but also different categories within your cashflow cycle. And so the way that we describe these are really three buckets, right? So you have a short term bucket, which is going to be in terms of short term, a few months out to two years, and really thinking about what might come up within your life. This could be an extension of your emergency savings. This could be an extension of your withdrawal or distribution plan, but really a way for us to get money to you in a safe and secure manner that is not experiencing market volatility.

From there, you have a midterm bucket of money. When we say midterm, we typically are speaking two to five years out in terms of an investment timeline.

And then you have a long term bucket of money, which is going to be the money that's invested really over five years. Sometimes depending on the clientele and their risk tolerance and their confidence in the markets, we might say this is money that is 10 years out. But it's important that all three of these buckets kind of act and work together – in a dance in a way. But it's more important that they are experiencing different types of returns and different volatility profiles.

Colin Day: Yeah. So maybe we start with a bucket so that we can visualize what we're talking about when we call when we talk about this three bucket approach. So let's talk [about] the shortest term bucket. What are we doing with that one? How are we populating that with money? How are we figuring that out with the help of the client?

Ryan Potts: Again, we're going back to the goals-based investing when you're talking about this. How we're figuring out how much we're going to populate into the short term bucket all depends on the client's goals. Do they have anything that's going to come up in the next two years where we are guaranteed to need that cash? Depending on who you are and depending on what cycle of investing you're in if you're in that accumulation phase, like I said, this could be just an extension of your emergency savings and saying that “Hey, I'm comfortable with only having 12 months worth of cash sitting on the sidelines.” Earning maybe a little bit more than what you're getting in your money market fund at the bank, but not much more than that. If you're someone in retirement, we're really figuring out how much [do you need] to withdraw from the portfolio on a monthly basis or an annualized basis? Just saying, “Hey, we want at least 12 months, up to 24 months worth of cash available to you that's not invested in the market.

I think that what we're doing with these funds – again, I alluded to it – but we're not looking to put money in the equity market. We're really not looking to put money in the fixed income market all too much. We're really just focused on safe, secure investments that are earning a little bit more than what you would get from maybe your bank account or your savings account.

Colin Day: Yeah, and for those of you playing at home, if you're thinking about, “How might this work for me in my situation?” You might say in my emergency fund to make sure that just in case something happens – break that glass, so to speak – I need to have $20,000 in cash at any one time. So if I was to lose my job to be able to pay the bills for a few months while I'm looking for work again, that's what I feel is a comfortable amount as an example.

Then on top of that, you might be thinking, “Okay, well, because I'm also planning on putting an addition on my house or I'm going to replace the roof,” or whatever big project, a big vacation, that may not be immediate, but maybe it's an expense of the next 6, 12, 18, maybe even 24 months, that gets layered on top of that. So I had a friend years ago ask me, “Hey, Colin, I've got money that I want to put for the down payment on my home. What do I do with it?” Ask the question, “When are you going to buy that house?” “Well, I think I'm going to buy it maybe next year.” “Cool, probably just keep it in the bank account.”

[They said,] “Well, that's not productive. [I said,] “Well, it might be more productive than you think, depending on what the market does.” As I try to explain to many folks, the longer the period of time you give a financial advisor to consider for an investment, the more confident we'll be in terms of the fact that we think it's going to be higher in terms of your performance, the amount of money that you're going to be able to pull out than where we're at currently. I think it's fair, because if you think about it, over longer periods of time, generally speaking, the market goes up and to the right. We've got that chart that goes in this direction. Whereas if you give it a shorter time period, “Hey, Colin, how's the market going to perform in the next three months, six months?” Lots of conversations around recessions, everybody's going to talk about the election or whatever else is going on out there. It's harder to feel committed to saying, “Yeah, I know that the market is going to do well. So yeah, let's go ahead and put it in.” Whereas, “Hey, you have the short term expense. I'd rather you know the amount of money that you have in your account to spend towards that goal. Let's just put that on the sidelines, put it into something relatively productive, whether it's your money market, a CD at the bank, treasury, whatever it could be.” Let's just put it in something relatively secure for that, that shortest term period.

And that is the short term bucket. But –

Ryan Potts: And for those listening – really quickly – the things that we have listed as types of investments that would be in your short term bucket, Colin said it too, but money market funds, ultra short duration bond funds, treasuries, or anything that really helps you, the client sleep at night. So you know the money is secure and we shouldn't be experiencing huge drops in these funds.

Colin Day: Yeah, absolutely. So that is the short term bucket. Let's go to the next bucket. Let's talk about the midterm buckets or however you want to put it. So why don't you take a stab at it?

Ryan Potts: So the midterm bucket of money for us is essentially, “Okay, we know we have a little bit more of a timeline here in terms of we want to continue to beat inflation with these assets because we know it might be longer than two years out what you might be spending these funds for.

We categorize this as more of a conservative style of investing. So again, we're not dumping all your money into the equity market in this bucket, but we are looking to achieve a little bit of growth. And more specifically, we want income. We use the midterm bucket of money as a way to replenish that short term bucket of money.

This might only really correlate with someone who is in retirement and is taking that monthly distribution from the portfolio. But it could correlate to somebody who's in the accumulation phase as well. Maybe you do decide to take that vacation and you draw down your short term bucket of money.

Our goal here is to achieve a little bit of growth, achieve a little bit of income within the midterm bucket of money, use the gains that we're receiving in this bucket to then replenish the short term bucket. Now the reason we don't want to put money into more equities here predominantly is because we know that – to Colin’s point – if we're talking to three, even four or five years out, we can't guarantee the market’s going to be positive within those time frames. It's not really until you get to maybe the 10 year timeframe where you look at history, and it shows us that over 90% of the time equities are up over a 10 year period. So what would we own in this midterm bucket of money? Well, conservative investments that still need to beat inflation over three to five years. So what would that be? These would be more like corporate bonds, municipal bonds, anything that's achieving an income slightly greater than inflation would be a home run for us. We might be looking to own a little bit of equities here, but they're going to be your “safer” equities. More value plays, not your high flyers like Nvidia, Tesla, Apple, Microsoft, those kinds of names. I think that the target rate of return here again is inflation, plus a couple.

Colin Day: And I think that's fair because we're talking about a slightly longer time period. We're talking about not needing these funds within a very specific time. We want it to be productive, we want it to be productive within the time horizon that we're considering for this. To Ryan's point – again, if we're visualizing this, if you close your eyes (if you're driving [and] listening to this, please don't close your eyes. Do this later) – but if we want to visualize the approach as to, “Okay, so now we've got two of the three buckets. How are these two buckets interacting with each other?” Well, the cash bucket just receives and it spends. That's all it does. It's not really earning much in most economic conditions where interest rates are fairly low.

So we have to replenish that money because you will be spending. So if you imagine yourself in retirement, you're spending down your cash. Eventually, you're going to get to a point where there's not a lot of cash left in there. So we have to replenish the bucket. How do we do that? Well, we start with the midterm bucket. We take the midterm bucket, we pour into the short term bucket. So if I’m a human holding a bucket in my hands. I'm pouring into a bucket that's on the floor. That's the short term bucket. I am holding onto the midterm bucket, which is being relatively productive in a somewhat conservative, moderately conservative type of portfolio.

But what's gonna refill this bucket that I'm holding, right?

Ryan Potts: Well, we're going to stair-step up one more bucket and go to the long term bucket.

Colin Day: So just imagine a human riding on top of another human holding a bucket higher – No, I'm just kidding. Go ahead, sorry.

Ryan Potts: Essentially, no. As long as that bucket is higher than the midterm.

But the long term bucket of money – and this is gonna be that money that is definitely your most aggressive allocation within your portfolio. It's also going to probably be your largest chunk of assets. And this is money that needs to be invested for 10, 20, 30 years. So if it's in your accumulation years, it's even longer than that, but for retirees, this is the money that's going to get you to the age of 80, 90, 100. Or this is going to be the money that gets gifted to your kids or grandchildren, the rest of the family or charities or whatever that might look like further down the line.

We typically say that because this is your largest chunk of assets and because it's going to be the most important in terms of that long term growth – because again, we're trying to beat inflation throughout retirement and make sure that you're not running out of money – it's going to be a little bit more aggressive than the rest of the portfolio.

We can look at closer to an 80% equity, 20% fixed income, all the way up to a 100% equities in this type of an allocation. But the thought process here, going back to the buckets though, is you look at a year like 2023, okay? The stock market was up 26%, roughly. This bucket of money should have been close to pacing that 26%. Not saying it was going to be 26%, but it should have been up there in terms of returns. The same way that in 2022, though, this bucket of money probably was down double digits as well. A year like last year, we maybe say, “Hey, we did such a great job with this long term bucket of money. We earned 20%+ in it. We're going to take some of those gains and shuffle those down to the mid term bucket of money. Where the mid term bucket of money didn't achieve a 20% rate of return. You maybe achieved 10% rate of return. Or even less than that.

Colin Day: That's pretty good.

Ryan Potts: Possibly less than that. More than likely.

But then you would take that 7-10% from that mid term bucket of money and move it down to your short term, which again, we're not really investing. We're just letting it sit in ultra safe investments, money markets, mutual funds, CDs, short term bond funds.

Ultimately, you build the structure, you have what we call the waterfall effect, where you have the long term bucket of money, the bucket at the top, constantly refilling your mid term bucket of money. As that becomes full, that then spills over into your short term bucket of money. And this should ultimately provide you a strategic withdrawal strategy that – knock on wood – doesn't run out of money.

Colin Day: Right, right. And that's the point, right? Is that this is a structure that we use for retirees exclusively, there's a whole bucketing structure in terms of “How do we come up with the numbers?” So you might be asking, how do we come up with the numbers in terms of what should be in short term? What should be a mid? What should be in long term?

What we have in our notes here that we can't go into detail today would be what are the accounts that we're considering within all these? Because we talked about – a checking account is probably the most basic form of cash that you're gonna have in that short term bucket. But what account should be the midterm bucket? Does it have to be one account? It can be multiple different types of accounts. If I've got a traditional IRA, or Roth IRA, where is that positioning within all these buckets? [That’s] outside the purview of this conversation, because there's tax implications and the other way of thinking as well.

But, that's a part of the fun thing that we get to do, at least from the planning side. To talk through and conceptualize what it could look like to then determine what is most appropriate. The other thing that I think is interesting with all this is, why the bucketing approach in the first place? Which again, is to make sure that the money lasts long enough. But it's also so that you as the client, as the individual that's going through this planning adventure with us so that we can continue to monitor your finances throughout your retirement, is that we want to make sure that you can be in the market.

Like I said before, we thrive as advisors on time. If you give us the time horizon that we are considering, we feel more confident in the kind of advice that we can give you. We give you better advice. If we best understand you, your situation, and, in the scope of this conversation, when we're going to be spending those dollars.

If we know those things, we can invest in both good times – as Ryan described in 2023 – and in bad times, like in 2022. We have better confidence in terms of understanding, “Hey, just because the market isn't performing the way that we want [it] to right now, we still feel like it's important to maintain the strategies you're in.” Because like that long term bucket. Without the long term bucket that's taking on that aggressive risk, without having something there we have no way to replenish the money in the midterm bucket. And guess what? If we don't have enough money in the midterm bucket we don't have enough money to then replenish the short term bucket. And then what happens?

Ryan Potts: We run out of money.

Colin Day: You run out of money. So that is it. That is the beauty of this concept is the idea that we are just using three buckets of money, long term, mid term, short term. They're represented in different ways. There's different allocations to different kinds of portfolios and accounts because of taxes.

But it's this beauty of the simplistic structure that we can go through and depict, “Okay, here's what we need here, here, here. Here's the amount of risk that we need to have in these three accounts.” And we're going to have success as long as we adhere to the plan. Does that sound good?

Ryan Potts: That sounds phenomenal.

Colin Day: What else do we want to add?

Ryan Potts: I think the last thing when it comes to the bucket approach – and you already said it, I'm just going to say it again, because I think it's the most important aspect of this entire strategy. Our goal is to make sure as an investor that you stay invested. If your entire portfolio is allocated a certain way, there's two concerns that I have.

One, when you need to take withdrawals. Depending on what the market's doing that year, you might be hurting or helping yourself. That's not very strategic, and you're at the whims of the market at that point. And that's concerning for us because we don't want to do that.

The second strategy, which is the same thing essentially, but staying invested. If we know that we have some conservative allocations within your portfolio through the short term and through the mid term buckets, that allows us to be aggressive long term. And the biggest issue we have with investors – especially in retirement, if it's still in the accumulation phase, even – when the market drops 20% like it [did]in 2022, you get the panic and the concerns and all the emotions that come with investing, right?

By utilizing the bucket approach it helps us eliminate the emotions. Because we're able to pull up your statement and say, “Look, your short term and your mid term are nowhere near that 20 percent drawdown. Your long term is, that's great, but we know that's money that's being spent in 10 plus years, right?” So we shouldn't be too concerned with it. With all that being combined we are able to help you as an investor stay invested. And again, this is all goals based investing. We're just focused on getting you to ultimately to your goals.

Colin Day: Yep. And if you're nowhere near retirement. If you're nowhere near thinking about the strategy for the concept of how [you’re] going to be spending it, we could still adhere the same properties to it. We just think about it a little bit differently. When is this money going to be used? When am I buying the house? When are my kids going to college? What are the things that I wish to do in 15, 20 years time, which for many people in that situation is going to be retirement, of course.

But for other people that are looking at doing projects around the house, making sure that their kids can afford hockey or their current things that they're working through, it's a balancing act of everything.

So I really liked this conversation. I thought this was good. If you're interested in seeing an actual scenario where we go through a retiree couple, I actually have a video on YouTube. It was done back in – I think it was early 2022. It was about investing in a bear market. You could just look it up on our YouTube channel. If you aren't already subscribed, of course, you should subscribe because we post our quarterly webinars there. We did one last week about income tax planning, and we of course put all of our podcast videos up there too. So if you're not subscribed, please do so. And if you're not subscribed to this podcast, we hope you would do so as well.

So Ryan, any final thoughts for those viewers or listeners that might want to know more about buckets?

Ryan Potts: No, I think honestly –

Colin Day: Where's the best bucket? Is it at Ace or is it at Home Depot?

Ryan Potts: No, Home Depot for sure. Get the plastic ones that break a lot.

Colin Day: Yeah, those handles never last. Anyway, sorry.

Ryan Potts: I think that if you're curious to learn a little bit more about how the bucket approach would fit into your current situation and you're not sure how that would look, just reach out to one of us. That conversation is something that we're constantly drilling into our clients’ heads. So it's a really easy conversation to have. And we can pick apart your current portfolio and make sure you are utilizing a bucket strategy.

Colin Day: Exactly. All right, right. Thanks again for joining me today.

Ryan Potts: It's always a pleasure.

Colin Day: All right. Until next time at another Capital Conversation, signing off. Have a wonderful day.

The opinions expressed in this program are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security. It is only intended to provide education about the financial industry. To determine which investments may be appropriate for you, consult your financial advisor prior to investing.

As always, please remember investing involves risk and possible loss of principal capital. Please seek advice from a licensed professional. Correct Capital Wealth Management is a registered investment advisor. Advisory services are only offered.

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The goals-based bucketing system is a strategic approach to managing your finances for both short-term needs and long-term growth. If you're seeking to optimize your asset allocation and ensure your investments align with your financial goals, consider reaching out to Correct Capital Wealth Management. You can give us a call at 877-930-4015, contact us online, or schedule an appointment with a member of our advisor team. It only takes 15 minutes to find out if we’re a good fit.