If you don’t properly know how to invest your money, you could easily freak out at one of these downturns and sell your investments, locking in your losses for good.
Luckily, you can avoid freaking out by applying an interesting investing concept.
You’ll save a ton of money by avoiding selling your investments when they fall when you use this concept.
In fact, you’ll probably earn more money by buying more of your investments as they decrease in value.
Here’s what to do.
The concept that will help you avoid selling when your investments start falling is the money buckets system. In this system, you decide how much money to invest by segmenting all of your available money into three buckets.
The Short Term Bucket
The first bucket is your short term bucket. If you absolutely must have access to a certain amount of money in the near term, that money needs to be in cash or a cash equivalent like a CD. This allows you to make sure you will have access to it when you need it without worrying about it losing value.
While the time period of what you consider short term is up to you, some people consider as far away as five years from now as short term while others consider just one to three years from now as short term. Just make sure it is a time period you are comfortable with.
The Mid Term Bucket
Of course, not all of your money should be invested super conservatively. The next bucket is for money you’ll need in the mid term.
For me, this is for any money between my short term bucket and my long term bucket. That means anything less than eight to ten years out, but further out than my short term bucket, will be invested using my mid term strategy.
My mid term bucket strategy allows me to invest my money in things like bonds or lower risk securities. In general, I’m OK with this money decreasing in value a bit in the short term, but over the longer term is should appreciate in value quicker than inflation.
Don’t be too aggressive with this bucket or else you could end up with a downturn knocking out a significant amount of value and it may not recover before you end up needing to move the money to your short term bucket.
The Long Term Bucket
The long term bucket is my favorite bucket because I know I won’t need to touch it for at least eight to ten years, if not much longer. In reality, most of my money in my long term bucket won’t need to be touched for over thirty years.
The long term time horizon allows me to stomach potential large losses in order to obtain an overall higher return over my time horizon.
My long term bucket is invested mostly in stocks. Actually, more specifically I invest in index funds that invest in the stock market.
Even if this bucket dropped 50% in value tomorrow, I wouldn’t sell because I know over time the higher returns will continue earning me more money over the long run.
How To Apply Money Buckets To Your Finances
So let’s pretend you have three goals. Yes, this is a bit oversimplified, but it helps you apply the concept.
First, you want to buy a home in two years and in your mind you must absolutely buy this home no matter what. This would be considered a short term goal, so all of this money should be put in the short term bucket and invested in cash (like a savings or checking account), or cash equivalents like a certificate of deposit (CD).
This way, you’ll definitely be able to buy the house in two years as long as you can save enough money for the down payment. Even if the stock market dropped 50% tomorrow, this money would be safe.
For your next goal, your first child will be attending college in five years and you want to pay for half of their tuition. You already have a good chunk of money saved up, but in your mind you absolutely must pay for half of their tuition and your child will attend college starting exactly in five years.
In this case, I’d put the money you’ve set aside for your child’s tuition in the mid term bucket and invest it in something that takes a little bit more risk than cash, but is much less volatile than the stock market.
I’d probably invest this money in some sort of bonds or a very stable stock. Once the goal gets closer and turns into a short term goal, I’d shift the money into my short term bucket and switch to cash.
Finally, you plan on retiring in twenty years, but you may retire later if you haven’t hit your pre-retirement goals. This would definitely fall into the long term bucket and I would invest pretty heavily in index funds that invest in stocks in order to maximize my return.
However, you need to make sure you’re comfortable with that investment strategy by ensuring your long term investment money matches your risk tolerance.
If you’re a little more risk adverse, you’d want to limit your downside by investing in more conservative investments. If you’re a little less risk adverse, you may invest solely in stock based index funds.
As your retirement draws nearer, you may need to start moving part of your retirement money into your mid or short term bucket. Keep in mind, your retirement money will hopefully last you thirty years or more, so only the part of your retirement money that you’ll need in the next few years should end up in the short term and mid term buckets.
If you plan on still being retired ten years from now, the money for years ten through thirty will remain in the long term bucket.
Hopefully this bucket strategy of investing will help give you some peace of mind when it comes to your investments. If you stick to a customized bucket strategy that you create for your specific circumstances, you won’t have to worry as much about having money when you need it.
In fact, it will give you confidence to avoid selling your investments and actually continue investing when markets turn down which will make you even more money in the long term.
Have you ever used money buckets when it comes to investing your money? Does this sound like something that would help you feel better about your investing strategy and having your money when you need it? Let me know your thoughts in the comments below!
Photo by: Images_of_Money Text added by: Lance Cothern