Bozo Buckets.Module 1: Know When To Start Investing.
If you aren’t familiar with the ingenious (or idiotic?) analogy in the title, Bozo was a clown. He had a TV show that aired on WGN Chicago when I was a kid, and at the end of each show, several kids would compete in the game of Bozo Buckets (The Grand Prize). It’s painfully simple. Six plastic red buckets all lined up, each further from the contestant. You then had to sink a ping pong ball in each, in order, all the way up to number 6 to win.
There is a parallel here to finance. There are no shortcuts to investing responsibly, so we need to put in the work to fill each of our respective buckets in order to protect against the unknown, and set our future selves up for success.
Let’s get started.
Bucket 1: Credit Card Debt
This is the easiest and closest bucket. Credit card debt is kryptonite to saving and investing, and before doing anything else, you need to clear any debt and establish habits to pay your balances in full each month.
Credit interest is insanely high (20%+) as many know, and will consume any gains you are making elsewhere even against a modest balance. Think of the opposite. If you were making a 20% return on your money, grab the champagne. You’ve won. This is what the credit card companies are doing when you are unable to pay your balance in full.
Here are some basic steps to do better:
Pay highest-interest debt first
Budget in your payments. (check out our resources on constructing a Balance Sheet and Cash Flow to help here)
Consolidate. Transfer all balances to a new 0% card (introductory rate) and pay these off in the next 12 months. Similarly, you can take out a personal loan at a lower interest rate.
Create a debt management plan. Find outside help from a non-profit like InCharge.
For more help, I’ve dropped some links at the bottom. If debt is a challenge for you, bookmark this page, and come back when you’re ready. Remember, clearing your credit card debt is the best return you’re going to get on your money and time, not to mention your credit score!
If you’ve got those automated payments setup and looking at a $0 balance, take another ping-pong ball and head for Bucket 2.
Bucket 2: Emergency Savings
2020. That sums it up pretty well.
Unknown risks are always present, and can quickly upend your world. To help hedge this risk and cushion the impact, we need to have a highly-liquid emergency savings fund.
Break glass in case of emergency.
There is a lot of debate as to how much you should have stashed away for a rainy day, but it is some multiple of your monthly burn rate, typically between 3-9 months. If you plan on a 3 month buffer, look at the 3 months that you’ve spent the most in the last year, take the average and multiply by 3.
If you want to be more conservative (and you should), plan for 9 months. Take your average monthly spend over the last year, and discount it by 10%. Assume that you would be able to adjust your budget to some degree if push came to shove.
Keep this money in a high-yield savings account, money market, or short-term CD -> wherever you can get some interest accruing risk-free.
Your emergency savings is your backstop and will give you peace of mind while also ensuring that you wouldn’t need to tap your home equity, retirement savings, sell assets, or take out a personal loan if a pandemic were to strike.
Bucket 3: Earmarks
This bucket is focused on supporting life goals in the next 3-5 or so years. Examples include down payments for homes, cars, having a baby, tuition -> larger expenses with a known ‘need-by’ date that we don’t want to risk missing. These deserve their own dedicated account.
[For some, this may not apply and you can feel free to jump ahead. ]
Similar to a rainy day fund, you want to keep this money in safe and liquid accounts and/or investments. High-yield savings, CDs, or possibly bonds, but bonds are fairly useless these days.
There isn’t really a set amount to shoot for here as these are your life goals, but the 3-5 year mark isn’t completely arbitrary. For one, goals change, and you don’t necessarily want to lose too much purchasing power on your savings. Second, there is less risk across a 3 year period that you would lose a significant portion of your balance if invested in low volatility equities for example. Lastly, it takes time to save and build. ‘Things’ you want to buy for Christmas don’t need their own dedicated account for example. Or for that matter, anything in the next year or that requires less than say $1k.
If you’re saving for your child’s college tuition this is a bit different and you should think of it in the same way as one of your retirement accounts. A long horizon = less risk = you can invest in riskier assets like growth stocks (more on all this later). However, college savings accounts should be a much lower priority than your own retirement savings, i.e. they would be part of Bucket 6 down below. The basic reasoning is this….your child can take out an education loan, and in some ways, may be at an advantage without assets in their name or in a 529 account to qualify for financial aid. There are options. You, however, can’t take a loan out to retire.
The other reality is that education is probably going to change drastically in the next 10-20 years becoming cheaper and more accessible. The other alternative is to support your child’s education by sending them abroad. There are excellent programs, most taught in English, where tuition costs less than what you would spend on Amazon Prime Day. Plus there’s no better education than what you learn traveling and interacting with other cultures.
Time to move on!
Bucket 4: Employer Match 401(k)
Ok, we’ve made it past the run-of-the-mill savings accounts and finally getting into some investing. If you are fortunate enough to have an employer-sponsored 401(k) or Roth 401(k), you need to take advantage of it.
Two reasons: 1) Investments here can be made pre-tax and 2) they don’t count against your personal IRA contribution limits allowing you to sock more away each year for retirement.
So how much should you be diverting here? If your employer offers a match, for example, a 100% match up to 3%, then you need to contribute 3% at a minimum. You’re doubling your money, literally. This is the only ‘free lunch’ that’s offered in finance, so make sure to accept it.
As for a maximum it mainly comes down to your monthly budget. The IRS places maximum upper bounds at $20k per year on these contributions, but for the vast majority of us, that’s a pretty ridiculous percentage of our salary.
If your employer’s plan doesn’t offer a Roth option (and you would personally qualify for a Roth), 5% is probably a maximum to contribute here. The next module will provide more detail into each of these retirement accounts, so the ‘why’ will make more sense. The short answer is Roths are king and offer the best long-term benefits.
Without further ado.
Bucket 5: IRAs
Getting that free money from the employer, fo sho.
Now we’re ready to start investing freely. And the best place to start doing that is within a Roth or IRA account.
We will dedicate the next module to unpack all the details and considerations with these types of accounts, but for now, what you need to know is that you should max out contributions each year to these accounts before funding a brokerage account.
Currently these limits are $6k per year per individual. Max out your account. Max out your spouse’s account.
By large, the biggest advantage of these accounts is the tax advantage. All gains, dividends, and growth are tax-free year on year, so they are excellent accounts for more active DIY trading.
Roths you pay no taxes now or later -> contributions now come after you’ve paid Uncle Sam.
IRAs you pay taxes later on distributions -> contributions now are pre-tax and in some cases eligible for a deduction when you file. (Don’t bank on this though)
Either way you can’t really go wrong. A good rule of thumb is to pair your individual account with your employer account -> e.g. if it’s a traditional pre-tax 401(k), open a Roth, taking advantage of both tax benefits.
OK, you may need to tap out here, and if that’s the case, it means you’re crushing it. If you’ve filled all 5 of these buckets and still hungry for more, let’s move onto the final stage.
Bucket 6: Brokerage
A brokerage account provides access to buy and sell securities -> stocks, bonds, ETFs, and derivatives, but can also include currency, futures, and other asset classes. Most of the time, your IRA or Roth are brokerage accounts as well, the difference here is we’re no longer operating in a tax haven. This is a taxable account, so the investment strategies versus your retirement will be a bit different (more on that when we talk portfolios).
So why not stop at retirement accounts and just do your investing there?
For those who want to retire before age 55, or even before age 60, you’re going to need some compounding of your savings. That’s a big reason. Retirement contributions also have caps, so if/when you are able to go above and beyond that, you will need a home for your wealth.
The other is what we discussed in Module 0 on why investing matters. => There is no alternative to investing in securities to preserve and grow your wealth. So if you’re not doing that, you’re losing money.
The next question is how much of your money should you keep in taxable brokerage accounts?
The quick answer is everything in excess that you have after filling up buckets 1-5. These all had limits and overflow so to speak, your retirement accounts resetting each year. For example, it doesn’t make much sense to hold 3 years of expenses and hoard cash in an emergency savings account.
Now that we’ve beat the metaphor to death, all that’s left to do is keep investing.
And that’s where it gets interesting.
The ‘Great Pause’ or ‘The Lost Year’…whatever you want to call the year 2020 has issued in a tsunami of retail traders. If I were to warrant a guess, the majority haven’t been disciplined to get their financial world in order before jumping to the last stage of investing which is much closer to gambling when done without building such a foundation.
The dangerous part is if 2020 was your first entry into the world of investing, you will naively believe markets only go up.
Investing is easy.
Every pick is a winner.
Until it isn’t.
‘Only when the tide goes out, you discover who has been swimming naked.’ – Buffet
Let’s put on a bathing suit, yea?
Bucket 1 – How to Get Out Of Credit Card Debt
Bucket 1 – FTC Settling CC Debt
Bucket 2 – Emergency Fund Formula
Bucket 2 – Quick Guide to Emergency Fund
Bucket 3 – Where To Age Your Money For The Short-Term
Bucket 4 – 401(k) Withdrawals
Bucket 4 – 401(k) vs. Roth 401(k) Calculator
Disclaimer (sorry): Remember, supermoment does not provide tax, investment, or financial services and advice. Supermoment isn’t a registered investment advisor or CPA. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. In other words, it’s general info that is meant to educate. And you know the mantra, past performance is not indicative of future results. Investing involves risk including the possible loss of principal.