One of our favorite authors in the blogosphere is Morgan Housel, author of The Psychology of Money. He said something recently that really got us to thinking about why we believe so much in the power of a Bucket Strategy.
His advice was this: Save Like a Pessimist and Invest Like an Optimist.
So what does this mean, and why is it pertinent to what we do?
Mr. Housel notes that bad news, whether it’s related to finance or not, is incredibly common. Over any period of time, millions of different things can go wrong – which means that at least one of them is likely to be causing havoc at any given moment. This is especially true in the world of finance.
He says that saving like a pessimist “means you acknowledge the cold statistics of how common bad news is. It’s common at the global, national, local, business, and personal level. Save heavily, knowing with certainty that you’ll need a cushion to deal with the next banana peel… [with] enough room for error to make it to the next round.”
Our Bucket 1 acknowledges this fact. We expect things to go wrong over the short term: a market downturn, a recession, a bubble bursting – whatever it is, Bucket 1 is there with the goal of shielding us from the effects of those events, allowing us to potentially maintain the cash flow that we need to survive over the next five, six, seven years or more.
In fact, we’re so sure we’re going to need that income that we’re willing to sacrifice what could be potentially a much larger rate of return in exchange for certain guarantees that our income won’t be affected. Sure, Bucket 1 won’t earn much, but the potential comfort that comes with having our short-term needs covered by short-term assets is worth the lower returns. And right now, any positive return, even a small one is a LOT better than what the stock market is giving us – and that’s why we have Bucket #1.
So, over the short term, expect that bad things can happen at any time, for any reason.
But what about the long term? Don’t bad things happen over the long term too?
Well, let’s define what “long term” is. For financial planning purposes, we like to go out in the far long term: 13, 14, 15 years or more. This allows us to “invest like an optimist,” where we can expect to see a positive rate of return, regardless of what’s happening day-to-day and month-to-month. Why? Because history and Morningstar both tell us that over any rolling 15-year period of time, the stock market has always produced a positive result. Of course, nothing is guaranteed, but we can be confidently optimistic.
This is why we have a Bucket 3, which takes the very long-term approach. We’re willing to endure the short-term ups and downs of the market, because we’re optimistic that we’ll see a good enough rate of return over the long haul to be able to refill Buckets 1 and 2 when it’s time to do so.
As Morgan Housel put it: “All good investing comes down to surviving an inevitable chain of short-term setbacks and disappointments in order to enjoy long-term progress and compounding… If the odds are in your favor and you can keep them in your favor for a long time, you shouldn’t just be an optimist. You should be a ridiculous, full-blown, giddy optimistic.”
A bucket strategy follows this logic precisely. Bucket 1 expects pessimism, Bucket 3 expects optimism, and Bucket 2 has a little of both. It helps to keep this in mind when the markets are doing what they’ve been doing lately.
We think about this every single day at Accardi Financial Group. How can we help you the most with your bucket strategy? Just give us a call.
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