The trick is to set up multiple accounts, and mentally deal with them separately.
There is one strategy that is both intuitive and easy to implement, however: Divide up your overall portfolio and assign separate allocations to each goal.
This goal-based approach is a twist on the bucket approach. Instead of dividing your portfolio by time until withdrawal, which is what traditional Bucket strategies are designed to do, you are dividing your portfolio by each goal. Each is allocated separately and segregated into different accounts.
Even though all my accounts contribute to my net worth, I mentally treat them differently. I find it easier to save when I specify a purpose for each account. It also simplifies allocation decisions. The dollars allocated to my retirement accounts are “hands-off.” My short-term savings are used to cover unexpected expenses, vacations, and new living room furniture that my wife and I really need to buy. Extravagant saving is just that – I can tap into that money when I want to splurge on something.
Obviously, the goals of the Millennial or Gen Zer will be different from mine. And young adults just starting out in their careers will be less likely to be able to allocate all of their goals. The best part about the goal-based approach of allocation is that it is adaptable to a variety of situations. Here’s how it can work:
unexpected expensesUse a savings account to save for unexpected expenses. Think car repair, smartphone replacement, etc. Conservation of capital and easy access are key, so you should not expose this money to stock market volatility. Start with a small goal, like $1,000 or $2,000. You should have a portion of each paycheck deposited directly into this account and increase that amount with each increase. Ideally, you want to reach six months’ worth of living expenses.
Spray: In this savings account you’ll keep money for vacations and other guilt-free splurges. Because this money will be separate from money for necessities, you won’t feel guilty for using it for a last-minute weekend getaway. While there’s no magic number about how much should go into your separate account, think about what you want to splurge on. The price of this item or experience will give you a benchmark to target. The current default contribution to my separate account is $50 per month.
Both also commit to putting aside half of any unplanned income—gifts, tax refunds, exemptions, etc.—for unforeseen expenses and separate accounts. They add up in small amounts over time.
Big Ticket Purchases: The down payment for your first home should go into a separate savings account. Cash is king if you are planning to buy a home in the next few years. (You don’t want the stock market to take a downturn over time, leaving you short of the down-payment amount.) If your horizon is between five and 10 years, consider bonds. black Rockhandjob
Fidelity Investments and Invesco all offer defined-maturity bond funds. These funds mature around a specified date the way a real bond does. If your buying horizon is long, say 10 years, you can invest some money in dividend paying stocks. As with other accounts, automatically set aside a portion of your income each month.
Retirement: As a young investor, you have time. Hence one should invest their retirement savings very aggressively. You want to maximize the benefits of compounding by making a heavy allotment in stocks. Tax-advantaged savings accounts should be used as much as possible to avoid paying taxes on any actual capital gains and dividends.
If your employer offers a 401(k), take advantage of it and any employer matches. You should increase your savings every year until you withdraw at least 10% of your gross salary (15% is even better) annually.
If you don’t have a 401(k), open an IRA, Roth IRA, or both. You can contribute up to $6,000 per year to each account if you’re under 50 (based on the 2021 limit). The 10% of income benchmark applies here as well. Depending on your income level, you may need both a traditional and a Roth IRA to reach that 10% number.
Write to Mr. Rotblatt at [email protected]