The Motley Fool

How the ‘three bucket system’ could set you on the path to financial freedom

As a nation, we’re not very good at saving and investing for the future. Indeed, a recent study by Santander revealed that one in five of us aren’t saving for the future at all and that those of us who do save are putting away an average of just £150 per month. Furthermore, the study revealed that 80% of savers hold their money in savings accounts and cash ISAs, despite the fact the returns on these kind of accounts are almost negligible. 

It’s not rocket science to realise that these poor savings habits are going to prevent many people from living comfortably in retirement. However, with a little planning, financial freedom can be attainable for most of us. The key, as Robert Kiyosaki explains in his best-selling book Rich Dad Poor Dad, is to stop spending money on items that diminish in value, and instead buy assets that increase in value. 

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With that in mind, today I proffer a simple wealth management system that could set you on the path to financial freedom – the Three Bucket System.

The three buckets 

There are essentially three things you can do with each  salary cheque – spend the money, save it or invest it. The premise of the Three Bucket System, is that a portion of each month’s salary is allocated to a spending bucket, a savings bucket and an investing bucket.

The ratio used to divide between the buckets will vary from individual to individual, but the most important thing is that an effort is made to allocate funds to each one. Let’s take a closer look at them.

Spending

The spending bucket is self-explanatory and receives funds for everyday spending including rent, food and entertainment. This money needs to be easily accessible, so a current bank account is most likely the best place for these funds.

For many people, this bucket will consume a large part of their pay and that’s understandable, but an effort should be made to retain some funds for the other two.

Saving

The next bucket is the savings bucket and the purpose of this one is to accumulate funds for the medium term – between one and 10 years. These funds giver the saver options, and might be put towards a house deposit, a new car or even a holiday for example. This money should be held in low-risk savings vehicles such as high interest bank accounts or short-term fixed deposits. 

Investing

The last bucket is the investing one, and this is the key bucket for those looking to achieve financial freedom. It is designed with a timeframe of at least 10 years, with a goal of exponentially increasing your wealth over time. 

The capital here is put into long-term assets such as high-quality dividend stocks, which in the long run, should return around 8%-10% per annum – significantly higher than the funds in the savings bucket. That kind of return, compounded over time, will generate significant wealth, and could make the difference between being stuck in the rat race, and escaping from it. 

So next time you get paid, think about allocating your money between the three buckets. Even if just 5%-10% is directed towards the investing bucket, over time this money will accumulate, bringing you closer to achieving financial freedom.

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