FINANCIAL GOALS AND THE BUCKETS OF INVESTING
Bucketing not only helps you manage cash flow but also improve risk adjusted returns
Investing cannot be ‘one strategy fits all approach’. One approach that has gained popularity in recent years is the ‘bucket’ strategy. This involves dividing investments into different categories or buckets based on various factors. Each of the buckets represent a specific financial goal and time horizon. The number of buckets and their allocation will vary depending on an individual’s financial circumstances, risk tolerance and financial goals. Three common buckets are based on financial objectives that address short-term savings, medium-term goals, and long-term retirement investments.
Safety bucket: This typically comprises liquid or easily accessible assets that serve as an emergency fund or cash reserve. These funds are earmarked for unexpected expenses (including emergencies) or short-term financial goals. Investors usually opt for safe investments like liquid/short-term funds or term deposits to ensure liquidity and stability. Depending on the objectives and stage of life, ideally 6-18 months of cash flow should be kept aside in the safety bucket.
Medium-term bucket: This bucket focuses on achieving medium-term financial goals (ranging from 3-7 years) such as buying a house, funding education, or saving for a dream vacation. Typically, investments in this bucket can be allocated to a mix of assets like stocks, bonds, exchange-traded funds, alternative investment funds (AIFs), portfolio management services (PMS), and mutual funds. The goal is to strike a balance between growth and market volatility. The time horizon coincides with typical market cycles and aligns you in a way that you do not liquidate assets in times of short-term volatility.
Long-term bucket: This is designed to provide financial security during retirement. Investments in this bucket usually have a long-time horizon (more than seven years), allowing for higher-risk tolerance. Common investment options include a diversified portfolio of stocks, long-term bonds, real estate, PMSs and AIFs. These assets have the potential to deliver better returns but are also volatile or illiquid (in specific cases) and so the time horizon needs to be well thought out and planned. Bucketing will not only help you manage the cash flow but also earn better risk adjusted returns. There are broadly two ways in which you can bucket your portfolio – time-based bucketing and asset-based bucketing. The former will allow you to manage risk and liquidity based on your defined goals within a timeline, while asset-based bucketing will help you to manage risk and liquidity based on diversification across asset classes.
Benefits of the bucket strategy: Goal-oriented approach: By allocating investments to specific buckets, investors can align their portfolios with their financial objectives. This clarity helps in determining the appropriate asset allocation and investment strategies for each bucket.
Risk management: Segmenting investments into buckets based on risk tolerance allows investors to manage risk effectively. By segregating short-term savings and maintaining a conservative approach, investors can safeguard funds required for emergencies. Meanwhile, long-term buckets can be more aggressive, aiming for higher returns and capital growth over time. Investors should build a portfolio with low correlation to protect the downside.
Psychological comfort: Bucket investing provides psychological comfort to investors, particularly during market volatility. By knowing that short-term needs are well-catered for in the short-term savings bucket, investors can ride out market downturns with confidence, rather than making impulsive investment decisions based on short-term market fluctuations.
The bucket strategy offers a structured and goal-oriented approach to investment management. With this, investors can effectively manage risk, liquidity needs, and long-term growth potential. It provides a clear path towards achieving financial goals while ensuring stability and flexibility. Remember to regularly review and rebalance the buckets as financial circumstances evolve, and market conditions fluctuate and on the other side, avoid biases towards any particular stock/sector/asset class/ investment style. Ultimately, the bucket strategy empowers investors to take control of their portfolios and work towards desired financial outcomes.
Vineet Sachdeva is entrepreneur partner-Quantitative Equity Investing, Alpha Alternatives.