I hate when financial advisors start talking about buckets. It makes me want to punch them in the nose. You know what I’m talking about—the bucket strategy. You got your growth buck—the one with stocks and mutual funds. I hear financial advisors say this one grows at about 10 percent. Then there is the next bucket which is safer—bonds. Bonds of course might yield you a whopping 3 percent! That’s exciting. Then of course you have your cash bucket with savings accounts, money markets etc which are growing at less than 1 percent in the bank.
Of course most people will die broke if they get returns of 3 percent. Why? Let’s do the math. There is a formula called the rule of 72 for compounding interest. Divide 72 by the percent of yield of an investment and you get the number of years that it will take to double your money. So, if the wealth advisor was right, and you got 10 percent on your stocks, you could double that money in 72/10 or 7.2 years. But what if you’re growing at 3 percent in bonds? Well, 72/3 equals 24 years! Ok, so what if you are growing at 1 percent, which I should add, is excessively high for a money market or saving account? 72/1 equals 72—so it would take 72 years for your money to double. We haven’t even included inflation in these calculations. With inflation of 2 percent, you would actually lose money on cash in the bank!
The conclusion here is that for most people, unless you get some significant returns on the stock market, you are pretty much screwed with this bucket approach. I know what you’re thinking, “But Buck, my financial advisor says that the growth bucket will expand 10 percent every year!’ To that I say—show me what’s in that bucket. How’s it going to grow at 10 percent? Ask your financial advisor what’s in that bucket. He doesn’t know. If he new, people would not have lost 40-50 percent of their money in 2008. It’s not a growth bucket folks, it’s pandora’s box. When you invest in the stock markets, you are investing in hope—that’s all. Is that a good strategy for your future?
I prefer control over hope. That’s why I never invest in things I don’t understand. I don’t understand why the stock market goes up and down on emotion. I don’t understand why corporate earnings have been the same for 3 years while the Dow has gone up by 25 percent. So here’s a simple rule I use that might be of use to you. If you can’t explain how an investment makes you money by drawing it out on the back of a napkin, then don’t invest. That’s my rule and it has served me well.