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What is the 3 Bucket Strategy? (And How to Do It Right)

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January 27, 2025

TLDR: Discusses the 3 bucket strategy for diversifying retirement accounts beyond target date funds.

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In this insightful episode of the Money Guy Show, hosts Brian Preston and Bo Hanson delve deeply into the 3 Bucket Strategy for retirement, answering listener questions about diversifying retirement accounts and optimizing saving strategies. This guide aims to help individuals navigate their financial journey effectively.

What is the 3 Bucket Strategy?

The 3 Bucket Strategy divides your investments into three categories:

  • Tax-Deferred Bucket: This is where your 401(k)s and traditional IRAs reside. These accounts grow tax-free until withdrawal.
  • Tax-Free Bucket: Comprising Roth IRAs and HSAs, this bucket allows for tax-free growth and withdrawals, making it ideal for future tax advantages.
  • After-Tax Bucket: This includes regular brokerage accounts that use after-tax contributions, resulting in capital gains tax on earnings.

Having these three distinct buckets allows retirees to manage their income withdrawals strategically. By choosing where to withdraw funds based on tax implications, individuals can significantly reduce their tax burden, even with large portfolios.

When to Consider Diversifying Beyond Target Date Funds

The discussion also touches on the appropriate timing for moving away from target date funds. Target date funds adjust risk over time but can limit the effectiveness of investment strategies as your financial situation evolves. Here are some key points:

  • Establish a Savings Habit: Initially, it's more important to establish strong saving habits rather than focusing on specific investment placements.
  • Understand Your Savings Rate: Aim to save a minimum of 25% of your gross income, allowing you to transition to intermediate strategies like the 3 Bucket Strategy.
  • Evaluate Investment Needs: Once you've solidified your saving routine and reached a level of financial stability, it may be time to explore more nuanced investment options beyond standard target date funds.

Key Takeaways from Listener Questions

Financial Order of Operations

An essential theme discussed is the Financial Order of Operations, emphasizing the importance of following a specific saving and investing sequence:

  1. Max out contributions to tax-advantaged accounts like Roth IRAs and HSAs before diving into 401(k) contributions past the 25% threshold.
  2. Once you hit that savings rate, you can begin exploring advanced strategies, including the 3 Bucket Strategy and focusing on other future financial goals.

Balancing Debt and Wealth Building

Listeners shared queries about maintaining a balance between leveraging debt for home ownership (such as putting down 35-40%) and continuing wealth building pursuits. Key advice includes:

  • Opportunity Costs: Understand that using large down payments can impact your ability to save for other investments, making it crucial to evaluate your financial priorities carefully.
  • Long-Term Planning: Assure that high housing costs do not hinder other aspects of financial health, such as retirement savings or emergency funds.

The Importance of Awareness in Financial Behavior

The hosts encourage listeners to regularly assess their net worth, emphasizing how understanding financial progress can motivate positive behavior changes:

  • Net Worth Tracking: Consistently track your net worth to observe growth over time and refine your financial strategies accordingly.
  • Set Goals: Having clear goals can keep you focused and disciplined in your saving and investing habits.

Conclusion

In summary, the 3 Bucket Strategy offers a robust framework for organizing retirement savings, while understanding the timing of diversifying away from target date funds is critical for long-term financial success. As financial awareness grows and disciplined saving becomes routine, individuals can position themselves effectively for a secure financial future.

For anyone navigating their way through retirement planning, the teachings from this episode provide invaluable insights and practical applications that can lead to a more fulfilling financial journey.

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