Investing can be hard. The firm DALBAR publishes an annual study that measures inflows and outflows of mutual funds. Their findings suggest investors have lagged the market by about 4% over the last 20 years.* Why? Because they tend to sell when the market hits a low and get back in after the market has recovered, in contrast to the idea of “buy low, sell high.”
Modern theory teaches to create an investment portfolio aligned with your long-term financial horizon then let it ride through market ups and down. However, it’s really tough to gut through a tortuous bear market in years like 2002 and 2008/09, especially for older investors who might be nearing or at retirement. If that person panics and liquidates to cash during a downturn then they risk earning a lower return than they might need to fuel spending in later years.
However, dusting off an old idea might help solve this problem. Employing a “bucket approach” to your investment accounts may provide confidence to stay invested during poor market cycles. This approach was recently outlined in a research paper published in the Investments & Wealth Monitor, a journal of the Investment Managers Consultants Association.** The concept was culled from research conducted in 1958 by Nobel Laureate, James Tobin.
The authors suggest parceling your investment portfolio into several distinct buckets based upon the time horizon for need and portfolio risk. For instance, a person at retirement might establish a bucket approach in this manner:
- Bucket #1 - Money that will be spent in the next 10 years should be invested in a conservative bucket such as a 30/70% stock to bond ratio with rather modest volatility.
- Bucket #2 – Investments earmarked for spending starting in 10 years and lasting through year 20 would be invested in a more moderate portfolio which might be in the range of 50/50% stock to bond.
- Bucket #3 – Investments for spending needs starting in 20 or more years could be invested in a growth type portfolio that might be along the lines of 70/30% stock to bond.
The total asset mix of the three combined portfolios might actually approximate a 60/40% portfolio, and thus, have a comparable overall return and risk potential. However, by segregating investments by time and risk, your mental accounting of the three separate portfolios may result in a more rational approach to a bad market cycle. Though you may see a large drop in their growth bucket during a downturn, you will understand that bucket won’t be touched for 20 years which is plenty of time to recover. Furthermore, you have the security of the low risk bucket for near and intermediate term needs.
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The scenarios outlined above are merely simple illustrations of how this concept might be employed and not a recommendation. Investors will need to work with their advisor to tailor a bucket approach specific to their own individual situation based upon projected spending needs and personal risk tolerance.
Though the bucket concept may be relatively new to individual investors, it’s not uncommon in the institutional investment world. Insurance companies, pension funds and other organizations often utilize a bucket-like approach of matching current assets to future liabilities. Implementing a bucket approach for your investments may help you stay confident while navigating through ongoing up and down movements of all market cycles.
For more information on financial planning, and other financial services needs, contact Treloar and Heisel, Inc. at 800-345-6040 or visit www.treloaronline.com.
*”2013 Quantitative Analysis of Investor Behavior”, DALBAR, 3/26/2013
**William D. Olinger III, CIMA and Benjamin Doty, CFA, “The Bucket Concept, an Old Idea for a New Market”, Investments & Wealth Monitor, Top Three Asset Allocation Articles 2013, Investment Management Consultants Association, 2013
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