There are thousands of articles on the web about personal finance, hundreds of books written on the subject, and even classes taught on college campuses. In my opinion it shouldn’t be that complicated. Someone once explained to me that there are five buckets of money for personal finance and I was amazed at how simple he made it. The idea is to fill each bucket up first in order and then as the bucket starts to fill up and overflow the funds will then spill into the next bucket.
Each week I plan on going into more detail about each "bucket"
1. Cash – Liquid investments that you can use for your day-to-day living expenses.
a. Checking Account – typically have 1-2 month’s worth of expenses in here as this is used for your everyday transactions.
b. Savings Account – typically have 3-6 month’s worth of expenses in here as this is your emergency/opportunity fund.
2. Insurance – Illiquid investments that you use for protection
a. Disability Insurance – typically replaces income in the event that you become sick or injured beyond a 3-month period. Benefits typically don’t start until 3 months after the incident first occurs, hence the reason for the 3-6 months emergency fund in your savings
b. Life Insurance – in case you pass away this typically is used for three things; cover any existing debt or obligations you might have i.e. cars, mortgages, credit etc. replace any income to dependents, and lastly to leave a legacy whether it is your kids college education, a charity you wish to support, or anything you were passionate about
c. Health Insurance – to cover the costs of diagnostic tests, surgeries, medicine, etc.
d. Property Insurance – to cover the costs of any damages done to expensive property i.e. cars, homes, equipment, etc.
3. Qualified Retirement Accounts – Tax favorable savings for retirement. Typically you’ll want to put away 5-10% of your income into each account. Deferring taxes, lowering taxes, or avoiding taxes all together saves you tons of money in the long run.
a. Pre-tax savings – 401k’s and IRA’s offer a way to put money away while lowering your current year tax liability.
b. Post-tax savings – Roth IRA’s offer a way to put money away while lowering your future year’s tax liability
4. Real Estate – you have to have a place to live with a roof over your head, why not make it profitable for you?
a. Most buyers will put anywhere between 10-20% down on a home
b. The idea is to own a home so that each month you are paying for housing you’ll see that money back in the form of equity, where as with renting it simply is an expense you’ll never see again
5. Non-Qualified Investments – Typically your last bucket to fill, which I like to call your “strike it rich” bucket
a. Non-Qualified Investments can be anything you want, whether it is a small business you want to start up, or a business you want to invest in there are little restrictions. Typically this bucket is the bucket in which we use “other people’s money” and leverage our investments and take slightly more of a risk. We are allowed to take bigger risks here since all the other buckets are filled and secure.
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