One of the important tenets of financial and retirement planning is to strategically match your upcoming liabilities (such as college funding, a second home purchase, or retirement income) to assets in your savings or investment accounts. Notice we mention two types of accounts, the savings account and the investment account. It’s not necessary to have two distinct and separate accounts, but you should know that there is a difference between saving and investing. Each is a distinct, yet flexible, strategy for covering future expenses, depending on your time frame.
You may have a specific, determinable expense coming in the next few years. For example, you may be planning to build or buy a new home in the next three years. Any monies you are going to need for this purchase should be set aside in a relatively safe and liquid account that would give you a reasonable expectation of having a specific dollar amount available at a specific time.
Such safe and liquid products include checking accounts, savings accounts, certificates of deposit, and money market funds. With these products, you trade safety and liquidity for lower returns. Although many of these accounts do pay interest, in today’s market the interest rates are very low.
When you’re saving money, you are more concerned with a return of your money. You want a certain amount available at a time certain. With investing, you desire a return on your money. You want your money to work for you and to grow, in order to fund goals that are further out in time. Also, the amount you need is not clearly defined and may be more of a target range.
Thus, you use your money to buy assets with the anticipation of receiving a profit or gain over time, and you expect a return greater than you would get from saving. To earn that return, you accept more risk, even to the extent that you could realize a loss on the investment. When you invest your money, the projected profit or gain will be in the future, but you are not sure exactly when in the future. And because all investments involve risk, you may never realize a profit. That is why money is often invested for longer periods of time: to allow for growth.
The Bucket Approach
To recap, savings are used to hold cash that you have identified for short term, identifiable needs (liabilities), such as 12 to 24 months of retirement cash flows, a future new car purchase, or an upcoming family vacation. Perhaps, if you are still working, your savings account would hold 6 to 8 months of household living expenses to cover any prolonged illness or loss of a job. All of these types of funds are held in a short-term savings “bucket.”
The investing bucket is everything else that you invest for longer-term requirements, like funding a 30-year retirement that will start in “around” 10 years. The primary goal of investing is to retain purchasing power and fight inflation. For example, if you plan to retire in 10 years at age 68, you could expect to live another 20 years, at least, after you retire. Everything will cost more in 10 years and, no doubt, everything will cost even more over the next 30 years. Inflation steals purchasing power slowly, and over 30 years a basket of groceries could double in price.
Bucket strategies allow you to address both your roles and goals as a saver and as an investor. The savings bucket allows you to match the near-term liabilities with short-term savings and is less affected by market volatility. The investing bucket allows you to harness market volatility and make the market work for you, in order to grow your investments to fund a need further in the future.
As always, Don and I appreciate and thank you for the opportunity to serve you and your family as your financial planners and wealth advisors. Please let us know if you have any questions.