Don’t shoot the messenger (or your advisor for that sake)! If you only pay attention to your quarterly/monthly statements, chances are high that you were fairly upset by the lack of performance reflected on your third quarter statement (the one you received in early October). In fact, the 3rd quarter (July 1 through September 30th 2011) was one of the worst performing quarters in recent history. So I forgive you if your emotions made you feel like calling my office and bailing out of the markets “again.”
However, the following 7-weeks provided a rocket ship ride to bring your equity prices back up 9.5%. This up/down/up may have given you that same feeling you get in your stomach when speeding along a rural mid-state California road that has those hidden dips!!
Here are some tips for creating a bucket of money investment strategy. Start by defining an investment timeline. If you know how much time you have until you need a certain amount of money, it makes understanding risk and volatility a lot easier. Here are examples of basic buckets of money:
Bucket #1, (your “now” money): If you had $200 cash in your wallet that’s earmarked for groceries this week, you wouldn’t invest it in stock or take it to Vegas and bet it all on red, would you! No, you would safeguard it so that you had no chance of losing any of your grocery purchasing power. If you lost any of it, you wouldn’t have enough time to recover the loss! You might also be hungry!
Bucket #2, (your emergency pad): If you had $40,000 saved up for emergencies (i.e. loss of job, medical, family need, etc.), you could probably put half of this money into an interest bearing savings account, and the other half into a 6-month to 1-year Certificate of Deposit. This money could remain virtually liquid, be FDIC insured, and attempt to grow enough to offset the bank/brokerage fees where it is held. In times of higher interest rates, the amount of growth could be fairly substantial.
Bucket #3, (your near term goal): If you were saving $500/mo. for a vacation home that you wanted to purchase in 10-years, you could probably invest that money into a balanced portfolio of bonds, stocks, real estate, and cash. Since you have 10-years to achieve this goal, you are willing to endure some periods of negative growth for the opportunity to potentially grow more over this longer term.
Bucket #4, (your long-term goal): If you had to put college money away for your 3-year old child, you would look for something to help offset the exorbitant costs of college…something that could potential provide for growth of your investment, but not be too conservative or risky! Here, you’d want to take advantage of some of the tax-deferred growth vehicles available for this purpose. Additionally, this is the only investment that has an actual defined timeline (in this case 15-18 years) down to the exact month and year!! Commonly these types of investments will start out somewhat aggressive, and transform into a conservative investment as college approaches.
Bucket #5, (your lifetime income money): If you inherited $500,000 at the age of 27 that you wanted to earmark for your retirement, you could invest in a manner designed to outpace inflation so that it could give you the ‘best chance’ of possibly having enough to retire on—without having to worry about running out of money. In this case, a 30, 40, or even 50-plus year goal of money would normally dictate a heavily weighted equities portfolio and would expect to experience several negative return periods/years throughout its term.
Bucket #6, (your play money): And finally, if you had extra money that you wanted to speculate with—and could afford to lose–, you could accept the most risk by investing in opportunities that offered the greatest reward if they come through (think Apple or Microsoft shares from the 1980’s), but have a fairly high likelihood of decreasing in value.
When you start to mentally and physically separate out different buckets of money for your goals, it’s much easier to accept risk appropriate for each particular investment timeline. Each time I open an account for a client, my compliance office at National Planning Corporation makes sure I ask “what is the timeline for this account.” It also asks “what is the “risk tolerance” for this specific account?” That makes it possible for the same person to be risk averse and tight fisted with one account while simultaneously being invested in another account that is highly volatile.
Define your risk tolerance. The vast majority of investors do not completely understand this statement/request. Commonly, people state that they do not want to risk losing ANY money whatsoever. However, they want to grow their money faster than the rates currently guaranteed by banks and the federal government (currently near 0%). As any reasonable investor should know that you can’t assume “no risk” and expect better than guaranteed rates of growth. The words “guaranteed” and “no-risk” should or could theoretically be translated to “the lowest prevailing rates.”
Give my office a call to review your risk, investment timeline, and goals. Together, we’ll ensure that you are invested in with a suitable amount of risk specific to your needs!