The Wall Street Journal- November 8, 2021
Young adults often need to balance building up short-term savings, setting aside money for big-ticket items like a home, and starting to build a retirement nest egg. And figuring out how to allocate a portfolio to achieve all of these goals can seem daunting at first.
There is a strategy that is both intuitive and easy to implement, however: Segment your overall portfolio and assign different allocations to each goal.
This goals-based approach is a twist on the bucket approach. Rather than segmenting your portfolio based on time until withdrawal, which is what traditional bucket strategies are designed to do, you are segmenting your portfolio by each goal. Each is allocated differently and separated into different accounts.
Even though all my accounts contribute to my overall wealth, I mentally treat them differently. I find it easier to save when I assign a purpose to each account. It also makes allocation decisions easier. Dollars allocated to my retirement accounts are “hands-off.” My short-term savings are used to cover unexpected expenses, vacations and the new living-room furniture my wife and I really need to buy. Splurge savings are just that—money I can tap when I want to splurge on something.
Obviously, the goals of a millennial or Gen Zer will be different from mine. And young adults just starting out in their careers will likely have less money to allocate to all their goals. What’s great about a goals-based approach to allocation is that it is adaptable to a variety of situations. Here’s how it could work:
Unexpected expenses: Use one savings account to save for unexpected expenses. Think car repair, smartphone replacement etc. Preservation of capital and easy access are key, so you shouldn’t have this money exposed to the volatility of the stock market. Start off with a small goal, say $1,000 or $2,000. You should have a portion of each paycheck directly deposited into this account and increase that amount with every raise. Ideally, you want to reach six months’ worth of living expenses.
Splurges: In this savings account you will keep money for vacations and other guilt-free splurges. Because this money will be separate from money for necessities, you won’t feel guilty tapping it for, say, a last-minute weekend getaway. While there is no magic number about how much should go into your splurge account, think about what you would want to splurge on. The price of this item or experience will give you a benchmark to aim for. The current default contribution to my splurge account is $50 per month.
For both the unexpected expenses and splurge accounts, also commit to putting in half of any unplanned income—gifts, tax refunds, rebates, etc. Those seemingly small amounts add up over time.
Big-ticket purchase: The down payment for, say, your first home should go into a different savings account. Cash is king if you are planning to buy a house within the next couple of years. (You don’t want an ill-timed drop in the stock market to leave you short on the down-payment amount.) If your horizon is between five and 10 years, consider bonds. Many companies offer defined-maturity bond funds. These funds mature around a prespecified date similar to the way an actual bond does. If your horizon for buying is longer, say 10 years, you could invest some of the money in dividend-paying stocks. Like the other accounts, automatically set aside a portion of your income each month.
Retirement: As a younger investor, you have time on your side. So your retirement savings should be invested very aggressively. You want to maximize the benefit of compounded returns by allocating heavily to stocks. Tax-advantaged saving accounts should be used as much as possible to avoid having to pay taxes on any realized capital gains and dividends.
If your employer offers a retirement plan, take advantage of it and any employer matches. You should increase your savings every year until you are socking away at least 10% of your gross pay annually (15% is even better). There are other options available if your employer doesn’t offer a retirement plan, but still aim to sock away at least 10% annually.
By Charles Rotblut
Write to Mr. Rotblut at reports@wsj.com
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