Here is a video from Morningstar where Harold Evensky of Evensky and Katz explains the Bucket System of investing.
This concept essential visualizes what most advisors do with Asset Allocation. According to Investopedia.com,
An investment strategy that aims to balance risk and reward by apportioning a portfolio’s assets according to an individual’s goals, risk tolerance and investment horizon.
The three main asset classes – equities, fixed-income, and cash and equivalents – have different levels of risk and return, so each will behave differently over time.
The cash and equivalent portion is usually 4% to 8% or 1 or 2 years worth of income and expenses. This takes care of the alternative bucket, or in this case, investment. Where most bucket investors get confused is that you don’t have to have the buckets in different accounts. It just makes it easier to conceptualize. You can actually invest different funds for the buckets in one account. Morningstar does a good job explaining this in some Sample Retirement Portfolios Using the Bucket Approach. The only caveat I would add is that you don’t need to diversify your buckets so much. As someone who subscribes in the KISS philosophy, I believe you could actually use a couple short and intermediate term funds for those buckets. What do you think?
