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When you’re gardening, you probably don’t use a pair of scissors to cut your grass, and if you’re putting a picture frame up on the wall, you’re not likely to be using a chainsaw. That’s because they’re not the right tools for the job.
When it comes to your finances, finding the right tool is just as important. You will almost certainly have many different financial goals and objectives you want to achieve throughout your life. These goals will all have different timescales, so the financial tools you need to use for each of them will also be different.
Today we’re going to cover what’s known as the bucket strategy for investing. It is a method of allocating your money that creates a clear and straightforward plan to help you reach your financial goals.
The bucket strategy is an investing strategy that suggests separating your money into different buckets based on your financial goals and objectives. It is important because there’s no one-size-fits-all investment or savings account that is the perfect option for all your goals.
If you’re saving for retirement in 30 years, a cash savings account that only pays 1% interest is a very poor choice. Similarly, using a pension fund you can’t touch until retirement is also a bad idea if you’re saving for a house deposit.
It’s about understanding when and how you need to access your money for a particular goal and then matching that to the right type of account.
The bucket strategy for investing has three main buckets: short-term bucket, medium-term bucket and long-term bucket.
Let’s take a look at each of these and cover the types of savings and investment accounts that are likely to be the best options.
We all have short-term goals. It could be a holiday in Portugal next summer, the new car you’ve got your eye on, or simply stashing away an emergency fund amidst plenty of economic turmoil.
Short-term goals have a couple of things in common. The first one is obvious—you have to achieve them within a short period of time. Generally, we consider a short-term goal to be anything less than three years.
The second point is that you need some certainty as to how much money you need to reach your goal. If a short-term goal is to build up an emergency fund of £5,000, you need to be able to do that without worrying that the value could fall quickly to £3,000.
That’s why investing in the stock market with your short-term bucket isn’t a good idea. The most common options here would be cash savings accounts and other secure accounts such as Premium Bonds or other NS&I products.
These aren’t going to get you any significant returns, but you can count on the money being there when you need it.
Looking forward a little, the medium term is often considered to be between three and five years. These are goals that are a little bit further away, but they’re also not in the distant future either.
The most common objective that will fit into this category would be saving for a house deposit. Getting these savings together can take several years, and it’s one of the main purchases in life that we plan far in advance for.
Another objective that could fit here would be planning to start a family. Again, lots of couples will have a broad future plan on when they want to try for children, and creating a financial reserve can allow for time off work or a reduction in hours once the baby arrives.
For this bucket, you could potentially start to consider investing in the stock market. Three years is generally considered the minimum time frame to look at investing, though five years is safer. It’s probably not the place to go full risk, though, so a diversified portfolio that includes more defensive investments like bonds can be an excellent middle ground.
The type of account you use will depend on what the objective is. If you’re saving for a property, the best option is most likely a Lifetime ISA. If you’re saving for anything else, you want an account that is as tax effective as possible whilst still allowing you to take out the money without penalty. A regular Stocks and Shares ISA will often be a good choice, and sometimes just a standard general investment account will work too.
The long-term bucket is for, you guessed it, long-term goals. These are goals that are much further away. Whilst technically anything over five years can be considered long-term, for most people, they’ll actually be a lot further away than that.
Once we get past our medium-term objectives, the most common financial milestone becomes retirement. For someone in their early 30’s, this could be another 30 years away—definitely long-term.
When looking that far into the future, you can afford to take on more risk with your investments. It’s likely that investing a significant percentage of your money into the stock market will give you better results over the long term, at the cost of more fluctuations in the value in the short term.
The obvious choice for retirement planning is a pension wrapper, but depending on your situation, you could also consider a Lifetime ISA or Stocks & Shares ISA.
Remember, it’s about finding the right tool for the job. Understanding how you plan to access the money and how long until you’re likely to need it will allow you to narrow down your options and choose the right one for you.
Read: Investing in the UK (in your 20s and 30s)
Also Read: What is a Pension?
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