The most terrifying word associated with money is tradeoff. Particularly among my fellow boomers, the mere mention of this word ignites the defense mechanisms in earnest. Yet, tradeoffs are required to accomplish financial goals. The horns of a dilemma indeed
One of our most important roles is to empower clients to understand tradeoffs, make good choices, and resist blowing themselves up financially. Among the tools that we use to help clients address the reality of tradeoffs is The Bucket Plan™ depicted below:The three buckets are named Consumption, Contingency, and Goals. Each individual bucket holds assets/accounts meant for a specific purpose and time frame. For instance, the Consumption bucket holds mostly cash and short-term bonds aimed at paying for regular living expenses anticipated within three years. Since no stock market funds are held inside the Consumption Bucket, clients can relax about the inevitable, but unpredictable, short-term stock market volatility. As an aside, the longest bear market time frame on record is about 2.8 years and the average about half that long.The underlying principle behind The Bucket Plan™ is the tradeoff between expected investment returns and time frame. That is, if you need money for consumption next month, the tradeoff is you can’t invest in something that has a long-term time horizon like stocks. The confusion or lack of clarity between the purpose for investing, the investing time frame and the particular investment vehicle explains much of the anxiety in the investing marketplace.
A simple way to look at what types of investments each bucket contains can be illustrated by what a professor of mine called “eight ounces of juice in an orange.” The concept is that every financial choice comes with a metaphorical orange and there are only eight ounces of juice available to divide between current income, capital gain potential, and safety. For instance, as the visual below shows, if you want 6 ounces of safety (no or low volatility), then you only have two ounces left for current income and capital gain.That creates a tradeoff that must be made between the different desirable outcomes and the innate incompatible aspects of each benefit. In our examples, tradeoffs are required since you can’t have a large number of ounces of safety AND a large number of ounces of current income. Why?…because there are only eight ounces of juice. This is a super easy way to look at what is sometimes called a forced choice matrix.By mentally and physically separating your financial assets, you remove the urge to make knee jerk short-term decisions and instead embrace the need for tradeoffs. The whole idea is to avoid anxiety about the days by shifting your focus to the years. Start there.
Related: The Real Financial Planning Pyramid