The current economy still has many of us feeling a little jittery. Economic news points to rough times, and some economists even wonder if we’re heading to a “double dip recession”. So what would you do differently if you knew we were heading for a recession?
Certified Financial Planner Ray Livetre uses his three bucket system to make sure you can weather any financial storm.
With this allocation method, you simply allocate your money based on when you are planning to spend it.
Picture three buckets in front of you. The first bucket contains money you plan on spending during the next one through three years. The second bucket contains money you will need to generate income from year four to year nine, and in the third bucket, you place money you don’t plan on spending for more than ten years.
The money in Bucket 1 is invested in cash-type investments that protect your principal (CDs, money markets, Treasury bills, bank savings accounts). This is your short-term money and is not put at risk by being invested in the stock or bond markets.
In Bucket 2, intermediate-term money is invested in bonds and or bond funds (corporate, government, municipal). You can structure your bond portfolio by purchasing bonds that mature each year from year three through year seven. This is known as a “bond ladder.” As each bond matures, money is available to provide income during the upcoming year. Bonds are guaranteed by the bond issuer and typically pay a higher rate of interest than cash-type investments. Although bonds will fluctuate in value, the volatility is usually far less than that of stocks.
Your long-term money in Bucket 3 is invested in stocks (individual stocks or stock mutual funds). This money won’t be spent for at least ten years. This is the growth portion of your portfolio and will naturally increase or decrease with the fluctuations in the stock market.
When handled properly, the pieces of this strategy fit together perfectly to ensure you a steady flow of retirement income. As you spend and deplete the money in your cash accounts, a bond will mature to replenish your cash reserves and provide the income needed during the upcoming year. To maintain your allocation, you will occasionally need to sell some stock positions to replenish your bond portfolio as bonds mature. If the stock market has a poor year, you can wait to transfer money from stocks to bonds, so you’re not selling stocks in a down market.
At any point, you are ensured to have income for nine years (three years via cash and six years via bonds). Consequently, you don’t need to worry excessively about a down year in the stock market because you’re not going to be spending any of your stock investments for at least seven years. In that lengthy time span, your stock portfolio has plenty of opportunity to regain any losses from a down year or two.
Let’s consider Catherine Dalton, a 60-year-old retiree who has accumulated $500,000 and has an income need of $25,000 per year. Following the income-needs allocation method, she has decided to invest $75,000 in secure cash investments to provide income during her first three years of retirement; $150,000 in bonds to provide income in years four through nine; and the remaining $275,000 in stocks to help meet her long-term retirement goals (see Figure 5):
Investing $275,000, or 55 percent of her money in stocks may be too aggressive for Catherine. If this is the case, she can adjust her portfolio very easily, making it more conservative by simply reducing her stock exposure and adding a little more money to bonds.
Now, let’s look at the case of Darin Zimmerman, age 30, who plans to retire at age 60. So far, he has accumulated $50,000 in his company’s 401(k) plan. Because retirement is far into the future, his primary goal is to see his money grow. He has a regular paycheck and doesn’t require any income from his investment portfolio. Choosing to use the income-needs allocation approach, he allocates his portfolio as shown in Figure 6.
As you can see, Darin has allocated 100 percent of his portfolio to stocks. This approach is much more aggressive than the age-based strategy, which would have allocated just 80 percent of Darin’s money to the stock market. Darin eschews the age-based approach because his priority is growth rather than income.
Ray is a certified financial planner and the author of the book, “20 Retirement Decisions You Need to Make Right Now.” If you are over 50, you can request a free copy of his book by visiting his website, http://networthadvice.com/ and clicking on the “Contact Us” button.