2779: Bucket Your Money by Jesse Cramer of Best Interest on Budgeting & Personal Finance Habits

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[00:00:52] a good tomorrow starts with a good night's sleep. Just search for Good Sleep in your podcast app and be sure to pick the one from Optimal Living Daily. This is Optimal Finance Daily Episode 2779, Bucket Your Money by Jesse Kramer of bestinterest.blog. And I'm your host

[00:01:13] and personal finance enthusiast Diana Merriam. Welcome back to Optimal Finance Daily, where every day I read some of the best personal finance blogs on the web in about 10 minutes or less. So with that, let's get right to it as we optimize your life. Bucket Your Money by Jesse

[00:01:34] Kramer of bestinterest.blog. An easy way to level up your finances is to bucket your money. What's bucketing? It's a mental accounting trick that helps both your objective financial plan and your subjective financial mindset. And it's really simple to implement. We'll start by dividing

[00:01:55] your liquid net worth, cash, stocks, bonds, etc., but not your home equity, car or other material goods into four buckets. These buckets look slightly different if you're still working or retired. So let's start with someone who's still working. Still working. If you're still working,

[00:02:16] your buckets are bucket number one, your next six months of expenses. Bucket number two, any big savings goals for the next one to two years. Bucket number three, any big savings goals for the next three to 10 years. And bucket number four, all money beyond 10 years, including

[00:02:37] retirement savings. If you're retired, and if you're retired, your buckets are bucket number one, the next six months of expenses. Bucket number two, month seven through year two's expenses. Bucket number three, year three through year 10's expenses. And bucket number four,

[00:02:59] all money to be spent beyond year 10. What to do with the buckets? Now you're asking, what do we do with each bucket? We invest them, but we don't invest them equally. The timeline of

[00:03:14] the bucket dictates the investment risk we can take. Short term buckets should be invested in a low or no risk manner. Long term buckets should be invested with more risk, pursuing more reward.

[00:03:27] Bucket number one is all about near term spending. It should be cash. It needs to be liquid and dependable since you need that money in the short term. You can't put these dollars at risk.

[00:03:39] Bucket number two, next two years, can take some risk, but not too much. You need to feel confident that your investment will maintain value or grow slightly larger in just two years. Short term

[00:03:52] bonds or certificates of deposit make sense here. Bucket number three permits even more risk. We have three to eight years to achieve investment growth. A mix of intermediate term bonds and stock funds can be appropriate here. And bucket number four's long timeline permits the most risk. Most

[00:04:13] of this money won't be spent for multiple decades. Stocks are an ideal asset in this bucket. My money don't wiggle. There's wiggle room on the timeline for each bucket. Some people think bucket number

[00:04:27] one only needs to be three months of expenses. Others argue it needs to be at least 12 months. Similar arguments can be made for each bucket. A year here or there, more or less risk in each

[00:04:40] bucket. This is the soft science of financial planning. Feel free to tweak your buckets, but maintain the overall idea. Let's walk through a few examples. Example number one, a typical young family. Let's talk about the Johnsons, a 40-year-old couple. They have two children ages 12 and 8.

[00:05:02] Their household spends $6,000 per month. Both parents are still working. They expect one of their cars has about two years of life left. Their older child will be starting college in six years. Based on this information, bucket number one contains six months of spending or $36,000.

[00:05:22] It's in a high-yield savings account at a bank. Bucket number two contains about 35 grand for their next car. That money is invested in two-year treasury notes, AAA rated, backed with the full faith and credit of the US government, earning 3% per year.

[00:05:40] Bucket number three has 150,000 earmarked for the first three years of college payments, years six, seven, and eight from now. That money is split between five-year treasury notes earning 3.3% per year and stock index funds. Bucket number four has another 300,000,

[00:05:59] the rest of the Johnsons' liquid assets, including their IRAs and 401k accounts. It's 100% invested in stock index funds, about 70% US-based companies and 30% international companies. Most of this money is retirement money that can't be touched for another 20 years.

[00:06:18] Since the Johnsons maintain a budget, they know their dual incomes can cover all of their day-to-day spending. Bucket number one is there in case of emergency. It's a safety net. The remaining three buckets are allocated based on the Johnsons' clear-cut goals and timelines.

[00:06:34] If their goals or timelines change, the dollar amounts in these buckets will change. You might wonder, what about the Johnsons' earnings? Where does new saved money go? Great question. The answer is, go bucket by bucket starting with bucket number one.

[00:06:50] Ask, is the money needed here? If it's not needed in buckets number one through three, then it goes to bucket number four. The Johnsons' first three buckets are fully funded for their goals. Their new savings don't need to go into those buckets, so it's placed into bucket number

[00:07:05] four and invested in the stock market. We can zoom out on the Johnsons' total portfolio allocation 36,000 in cash or 7% of their liquid net worth, 135,000 in bonds or 26%, and 350,000 in stocks or 67%. This portfolio is in family with a traditional 70-30 portfolio, but we built it

[00:07:29] from the ground up based on the Johnsons' unique circumstances. Example number two, the Smiths, age 62, just retired. Here are some of their stats. They have a million in their 401ks and IRAs. They plan on spending 50 grand per year in retirement. For their first five years

[00:07:49] of retirement, 100% of their spending will come from their savings. They'll start collecting Social Security at age 67, full retirement age, which will come from their savings. They'll start collecting Social Security at age 67, full retirement age, which will cover half of

[00:08:05] their spending needs thereafter. The Smiths' bucket number one contains 25 grand in cash for the next six months of spending. Bucket number two contains 75 grand for the following 18 months of spending, and it's invested in two-year treasury notes. Bucket number three contains 225,000 total.

[00:08:26] 150,000 is for years three to five before the Smiths start collecting Social Security. 75,000 is for years six through eight when half of their income will be supplied by Social Security. This 225,000 is split between five-year treasuries and stock index funds. Bucket number four contains

[00:08:48] their remaining 675,000 and is invested in stocks. If we zoom out on the Smiths' portfolio, we see 25 grand in cash or 2.5% of their liquid net worth, 225,000 in bonds or 22.5%, and 750,000 in stocks or 75%. This is roughly a 75-25 portfolio, which is aggressive for two

[00:09:16] retirees. But we need to consider that their Social Security should be considered fixed income, just like bonds. If we were to add their Social Security fixed income into their 25% bond allocation, we would see their portfolio ratio shift significantly. 25,000 in Social Security

[00:09:35] income is equivalent to owning 700,000 in bonds paying 3.5% per year. 25 grand in cash or 2% of their net worth. 225,000 in bonds plus 700,000 equivalent in Social Security is 925,000 in fixed income or 54%. And 750,000 in stocks is 44%. Ah, the Smiths' portfolio, including Social Security,

[00:10:04] resembles a 45-55 portfolio. That's much more in family with traditionally prescribed retirement portfolios. The difference, however, is that we built the Smiths' portfolio from the ground up using the bucket method. How to bucket your money. Use the examples of the Johnsons and

[00:10:24] the Smiths to bucket money in your life. Determine your goals, apply a timeline to them, allocate money to each goal, and take risk based on the required timeline. Depending on your age and your

[00:10:37] goals, you might find a unique proportion of money inside your buckets. That's okay. The point of this exercise is to build a portfolio unique to your life using an objective goals-based framework. Every approximately six months, revisit your buckets to ensure your portfolio is still aligned

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[00:12:30] I think Jesse makes a solid argument for four financial buckets, though it does make me a little bit envious of people who have this kind of clarity on financial goals and timelines. It probably would be more optimal to conservatively invest money you plan to use

[00:12:47] in the short or mid-term. But I find for myself that two buckets works better for my lifestyle. I have a really strong cash cushion that can cover any emergencies and opportunities that present themselves. And then I have my 100% stock investments that I don't plan to touch for many

[00:13:04] years, quietly working in the background. Some would argue that I'm holding too much cash. But for me, it's an answer to my lack of clarity when it comes to financial goals. For example, when I bought my house, it wasn't because I had this goal for years and steadily

[00:13:21] saved the down payment. An opportunity presented itself that I couldn't pass up, and I had the cash on hand. Also, when I was younger, I put some money into a CD, but then

[00:13:32] misjudged my timeline on when I would need the money, so ended up paying penalties to access it early. I also tend to go for simplicity over optimization at all costs when it comes to money management. My Midwestern gentleman and I already have an overwhelming number of financial accounts

[00:13:49] to track, from checking accounts to savings and retirement accounts, as well as credit cards we use for rewards points. I'm not sure that the benefits of the four bucket strategy described here are worth the complexity of more accounts. And that does it for another edition of Optimal

[00:14:07] Finance Daily. I hope your weekend is going well. Thank you for listening, and I'll be back with another post for you tomorrow. So I'll see you there where your optimal life awaits.