Episode 24: Maximizing your financial freedom with a 3 bucket strategy

The episode discusses the three-bucket strategy as a tool for achieving financial freedom and early retirement. It explains the concept of short-term, mid-term, and long-term buckets, offering advice on emergency funds, investment options, and retirement planning. The host emphasizes the importance of individualized planning and advises seeking professional guidance for financial decisions.

Check out the Palm Valley Wealth Management Website
PalmValleywm.com

Check us out on
Instagram
LinkedIn
Facebook
Listen to the Podcast Here!
Apple
Spotify

Transcript

Microphone (Scarlett 2i2 USB): 0:00

Do you want to maximize your financial freedom? Well then listen today about the three bucket strategy so you can do just that. And welcome back to the Retire Early Retire Now podcast. We're in episode 24 and today we're going to talk about the three bucket strategy. And there's a ton of places, a ton of rabbit holes we could go down when talking about the three bucket strategy, but today we're going to keep it in the confines of that early retirement. Uh, so if you're in your late thirties, To call it 55 years old. Uh, this podcast is really going to benefit you, uh, to, to better understand how to maximize that financial freedom, but, um, we have gained a ton of, uh, listeners over the last few weeks, so I just want to say thank you to that. And if you are liking this podcast, go ahead and subscribe so you can get the notifications every Tuesday morning so that you can get some education on your financial situation to better help you become financially free, but also retire early or retire now. And so let's jump right into this podcast. So again, the three bucket strategy. And this is something that, a lot of people maybe don't foresee. So if you work with a financial advisor, you may have heard of this before. Um, and some of this stuff you're going to have heard before because, big financial gurus talk about, certain parts of the three bucket strategy. but a lot of financial gurus don't necessarily. Talk about it in this manner. So the three bucket strategy. What is that? So we're gonna have a short term bucket a mid term short term bucket goal And then a long term bucket goal and then based off what's important to you is how we're going to structure These buckets right? And so we're gonna take the approach of I'm still in my 30s to 40s Maybe early 50s. I'm You still accumulating assets. And I know that I want to either retire early, um, or maybe transition into a different field where maybe I'm not working as much, or it's something a little bit more passionate about, um, owning your own business, uh, just a different field in general, whatever that may be. And so the first bucket is probably one that if you're listening to this podcast, you would probably have in place already or know that you should be working on it at the very least. And that is your emergency fund. That is that short term bucket that if I have a health event, I have my car break down, I have some sort of emergency, my A. C. goes out, I have cash on hand right now that I can pay for that fix, and I'm not having to go into debt to get the new A. C., a new tire, whatever that case may be. So, generally, we want to have this money in a high yield savings account. So, over the last year, year and a half, interest rates have been rising. because of that, you can actually get some relatively decent yield on cash now. So, getting into a money market is not uncommon to go four and a half, five, five and a half percent on your money. So, if you deem that you're Emergency fund needs to be 30, 000. Well, you can easily find, uh, either an online bank or your, the bank that you're in, and research a money market and get. Again, four and a half to five and a half percent, and there is little to no risk in in those funds. So, um, that would be a free rate of return on your money. how do we determine what our emergency fund should be? Well, generally, I would say that, you need somewhere between three and six months worth of your, expenditures in a given month. And this doesn't have to be your exact same lifestyle, how you're living now. Let's say you did get laid off for whatever reason, or you stopped working, generally most people are going to cut back on their spending. So when I say three to six months, I'm thinking, okay, well, if worse comes to worse, we can't go out to eat as much, or we can't take a vacation here or there until that transition is up. and I find a new job or recoup that income somehow. Um. Thank you. That's kind of how I want to determine how much we need in savings. And so generally if you have a pretty steady job, like a government job or salary job, then you know you're getting your paycheck twice a month and it's going to be X amount of dollars each month. And so generally I would say, oh we can lean toward the three months. Now, if you are commission based or your income fluctuates quite a bit, then we want to lean toward that six months because, you may have a down month where you got to tap into your savings periodically. And then if you have an extended period of time, maybe again, you lose your job or you're out of work for a certain amount of time. You want to make sure that because of that fluctuating income, you have enough cash on hand. That you can, make sure that you keep your lifestyle the same to be able to recover. make sure that when you determine whatever that number is, 20, whatever that amount is, you're not necessarily going to use it on a monthly basis. put that money into a money market. Get some yield on it. there's definitely some more, aggressive type of investments that you could get into, but the last thing you would want to do, is put that money into like an S and P fund or something, the market crash, you lose your job and now you have half as much savings as you thought you would initially. and now you're really worrying about, oh, can I, pay my bills for the next couple of months? Because, uh, I'm at a loss, right? So make sure that money is safe. The next thing that we'll talk about is the long term bucket. Again, the first two things we're going to talk about you probably heard before. the next thing is that long term bucket. So that would be, uh, especially if you're in your 30s, 40s, and early 50s, that would be your IRAs, your 401ks, Roth IRAs, uh, SEPs, maybe an annuity play if you, felt that that was a good fit for you. and generally these investments are more growth driven, so they're going to have more equities, more stock, whether that's through individual holdings, like if you're buying Apple individually, or if you're purchasing mutual funds or ETFs. So you're packaging those and then you're paying a manager to kind of either follow the index or actively trade to beat some sort of index that they're comparing against. and so we can debate on which one is better and all that. But, for the sake of this podcast episode, we're going to just say, Hey, we need some growth oriented investments. And so as you get closer to your retirement date or. Needing these funds. So not necessarily have to be retirement, but maybe you're just supplementing income because you're going to go part time from full time. we want to start to turn the dial down a little bit and maybe get into some fixed income so that we can slow down that volatility, because if you think about the last couple of years, there's been a ton of volatility where the market pulled back in 2022. then. The fed said, Oh, interest rates are going to slow down. Maybe we'll start pulling back in 2024 and you saw the market shoot up. And so if you're needing that money within the next, call it three to five years. the biggest risk to you, to you not having a successful retirement would be that sequence of returns. So you get into that first year, the market pulls back drastically, you participate in that pullback. Well, that's going to, decrease your likelihood of a successful retirement or change in whatever that you're doing. So, in this growth bucket, again, generally speaking, we have IRAs, 401ks, SEP IRAs, maybe solo K, things of that nature. We want that tax deferral and we're going to make sure that they're, we're growth oriented. And so this last bucket is the bucket that is not talked about, uh, very often, uh, Dave Ramsey does try to do a good job of talking about investing over and above, uh, your retirement accounts. But if you're wanting to retire early, or maybe you're wanting to start a business or just slow down, so there's. a podcast listener that I am working with right now We're kind of in the early stages, but he is in his 40s He's done a really good job of saving and what he's done is he's really built this metal bucket And this is something that I don't often see and so it's a conversation that I have to have with people is like, okay well you have all this money in your your retirement accounts, but How are we going to bridge that gap from age 45 to 60 or age 50 to 60, right? and then I have a friend that is considering leaving his job and starting his own business. having this middle bucket will certainly help him, transition from that. So he'll lose his daytime or day job income and he'll have to slowly build that side business that he's been working at for, a couple of years now. And so that middle bucket can help him transition as that income starts to pick up from that side job that is, uh, Eventually going to turn into his full time job, right? And so what is this middle bucket? So this middle bucket is generally Just a brokerage account So you're not going to get the tax benefits of let's say an IRA or 401k where if you put 10, 000 in there and it grows to 20, 000 40, 000 so on so forth Uh, where you're, as long as it's in that account, you're not going to pay taxes. That's not the case in this particular brokerage account, right? You're going to owe taxes, uh, every so often for a number of reasons that we can touch on. why you would pay taxes in a, a taxable account. Dividends, um, interest, and then capital gains, right? So if I buy Apple for 100 a share and then I sell Apple for 120 a share, depending on how long I hold Apple depends on the rate, but I will have some sort of capital gain of 20, right? And so if I've held it for longer than a year, it'll be long term capital gain rates. If I've held it less than a year, it'll be short term capital gain rates. Let's talk about that middle bucket. And, and so what you want to do is you really need to define what your goals are. So is it, is it hanging it up and retiring for good and just playing golf every day? Um, is it helping me transition to creating my own business? is it. Leaving my current job and doing something else, but on a part time basis, And then this can help you allocate both how much you should be saving and then the allocation of the investments inside of these accounts. So call it, do you have five years, 10 years, 15 years out before this event happens, whether it's retirement, starting a job. Or just transitioning to part time and then using that account to supplement that part time work. And then from there, you can decide whether you're going to be growth oriented or more income focused or just conservation of principle. And so that's why it's very important to determine what am I trying to achieve here. 000 foot view. How do we fund these? What should we be funding them at? if you talk to a traditional advisor or you're just Googling and you're taking a more traditional approach, most advice or education is going to be get your three to six months and then fund as much as you can into your retirement. But if your goal is a goal a lot like my clients. Your goal is to retire much earlier than 59 and a half. And if you do that, you're going to have to jump through significant hoops to start to try to, access some of that retirement money. And then you're starting to lose out on that deferred growth and those, tax advantages that are provided through your retirement accounts. So how do we fund these accounts? Like we talked about earlier we want to make sure that we have our three to six months in cash There's a number of places you can go for those money markets and one thing I failed to to mention early on if you don't know if your bank is giving a good money market rate. You can go to bank rate.com and then that will give you kind of a number of money market and CD rates that you can look at to see, is my bank competitive or should I look at going to a different bank? So check out bank rate.com to fund your savings account with that three to six months, depending on your situation. And so now it's okay. Well, I know I have my three to six months. I can save a significant amount of my income because I've kept my debt down or, or my income has increased, whatever that case may be. Well, how do I allocate, between my 401k and this middle bucket? Or how do I allocate between my IRA and this middle bucket? Well, first, if you are employed with, an employer and they're offering a match, Go ahead and get that match. So if you have to put in 4 percent to get 4 percent or 5 percent to get 4%, whatever that is, generally it's a dollar for dollar match. Sometimes it varies. but if you're getting a hundred percent of your money back, or, if you're putting in 4 percent and getting 4%, well, then you're getting a hundred percent return and as much as, I would love to say I could, or, Any other advisor say they could, they cannot get 100 percent return every single year. So get that free money. that is going to help your situation drastically in the longterm, right? So more money invested for a longer period of time. And then from there you want to determine, okay, well, what is. My ultimate goal here. Am I retiring early? Am I retiring at a normal age? am I starting a business where, for a handful of years I'm going to need to supplement my income? And then from that business, my income will actually exceed what I'm making now. and then I can start saving a little bit differently. And so you want to consider those factors, maybe you even want to take a sabbatical, right? I want to take a year or two off, enjoy my kids at a certain age or go travel, or just kind of revamp and do some things differently, whatever that case is, right? And so if you're more in the mindset of, I want to retire. Closer to that age 65 or 60, well then majority of that money would likely be better off going into those tax advantaged accounts. But, if you are more inclined to retire in your early 50s, late 40s, somewhere in there, where you're slowing down, maybe you're going part time. Well, then we need to start looking at, okay, well, how much do we need to fund my retirement accounts that at age 60 or 59 and a half, I can still pull off of those accounts and retire for, 30, 40 years. but how much do I need a portion off? So that I can bridge that gap from that time that I retired to that time that I hit age 59 and a half. And then from there, you can look at that middle bucket and go, okay, well, the time horizon of this middle bucket is 10, 15, 20 years. Well, I can be much more aggressive and I can get into, more equity heavy portfolios if my risk tolerance allows it. If I can sleep at night and understand that the, The ups and downs of those accounts may be, up and down quite a bit on a year to year basis, but I will have more opportunity for growth in the long term, or maybe I'm in a situation where I want to start a business in two years or five years, and I need a significant outlay. As long as that business is to get started and so I determine how much income I would need and then we want to take that and fund that and maybe we are funding portion of that middle bucket with cash and money market funds and then a portion of that for the more long term with some equities or fixed income to potentially get a little bit more growth for that money that we would need a little bit longer down the road. that may seem a little bit confusing, but really what I want you to get out of that in the last couple of minutes is it is very individualized to your situation. Everybody's going to be a little bit different on their time horizon. Everybody's going to be a little bit different on how much income they're going to need, how much income they can save. And in determined on that is. When some of these things can happen and how they're going to happen. And so what I would say is, if you're unsure on how much you should be allocating to each bucket, then One, you need to sit down and figure out what are my goals? What do I really want? Do I want to retire early? Do I want to start this business? What does that look like? And then from there you can start to backwards plan into, okay, well, how much is this going to cost and is it realistic that I get to that amount in that given time or what rate of return would I need, and if that rate of return is 20 or 30 percent on a year to year basis, well then. Maybe I need to save more so I don't have to take so much risk to get that particular return or try to achieve that amount of return. and then from there, if you're still confused, I would meet with an advisor and then you could walk through those scenarios with your advisor, right? And so what that advisor is going to do is, Ask a bunch of questions, understand your cash flow situation, understand what you have already done, and then go ahead and help you reallocate those buckets and continue to save if you, if you haven't reached that goal yet, or start to transition into that kind of, pre retiree stage or retiring, whatever that situation is. And so utilizing this three bucket approach can be very, very helpful to keeping things organized in your head and in your plan. but also, setting yourself up to be able to bridge from age, whatever that is to age 59 and a half when you could start touching these retirement accounts. So just consider that, the three bucket. strategy is something that I use quite often in my practice. I find it very helpful and it makes it very clear for clients to understand where they're at in their situation and how long it's going to take to get there. And then knowing, okay, this bucket needs to be here. when I'm ready to retire and this bucket needs to be here for my emergency fund, so on and so forth. And then as those buckets fill up, you can reallocate, cause what you're gonna see is those growth buckets are gonna grow really fast. and then those cash buckets may grow a little bit slower or your cash flow is growing because maybe you, Get a better job or that business you started, started to take off, whatever that case may be. And then you start to fund those other two buckets with that extra cash flow as well. if you would like some help to determine, Hey, can I retire early? am I funding these buckets properly? Go ahead and reach out on my website, palmvalleywm. com. Look at my process. I'd love to have a conversation with you, schedule a call and I can see what I can do to help you. And that'll do it for today. Stick around for the next couple weeks. We have some podcast guests that I mentioned last episode, but we have a CPA, coming on here in a couple of weeks. if there's a particular question that you have, not necessarily specific to your situation, but just tax questions in general, feel free to go ahead and find me on Instagram at palm underscore valley, underscore WM, DM me some questions. Would love to, to answer some of your questions, uh, that the CPA may have the answer to. Um, but, uh, stick around for that. again, if you're a new listener, thank you so much. Go ahead and share this with a friend. subscribe to your favorite podcasting app. So you get notified every Tuesday morning for these podcasts app. And again, you can find me at palm valley, wm. com or my Instagram palm underscore valley, underscore WM. And we'll see you in the next one. This podcast is for educational purposes only. This is not financial advice. This is not investment advice. This communication should not be relied upon as a sole factor for an investment making or financial planning decision. If you would like help, please seek a tax, financial, legal, or insurance professional. Please keep Palm Valley Wealth Management in mind when making those considerations.