Achieving financial independence is everyone’s goal. The dream of quitting the rat race and being able to live off your savings may seem like an unattainable goal to many but in reality, to achieve this, all you need is a little planning.
The key to building wealth is a regular savings plan. If you’re putting away a little every month, over time this savings pot will build up. The best way to ensure that your savings stay untouched, and grow steadily over time is to use a bucket approach.
Using financial buckets to segregate your wealth is easy way of making sure that your money works as hard as possible. It doesn’t require much effort and you’ll soon reap the rewards.
How you plan your buckets will obviously depend on your current financial situation, savings goals and position in life. But no matter how you divide your wealth, you should be better off for it.
A simple bucket approach would be to divide your wealth between current and long-term savings. Depending on your current financial situation you may believe it is prudent to put aside enough cash to meet three months of spending obligations as protection against unforeseen occurrences.
With this cash cushion in place, you can devote the rest of your wealth to savings products with a longer horizon, with the intention of locking these funds away. Inside this bucket you may then choose to have two more buckets, one of which carries more risk but a higher potential long-term return such as equities. The other would be low risk but offer a steady return — bonds might be appropriate.
Tricking yourself to save more
The great thing about the bucket approach is that, as well as encouraging saving and making sure that you don’t dip into your savings to meet near-term costs, it provides a psychological benefit.
Equities have generated a historic return of around 10% per annum, much more than offered by fixed interest. Nonetheless, this higher return comes with increased volatility, which may scare off some savers. But by using buckets there’s no need to fret about volatility.
Research has shown that investors tend to panic when the market falls and sell at any cost, a destructive strategy. However, if you have your near-term cash requirements satisfied in the lower-risk savings buckets described above, the chances of you deciding to sell at the market bottom are greatly reduced as you can afford to wait for equities to recover.
Shares in companies such as Royal Dutch Shell and GlaxoSmithKline may fall significantly during periods of market turbulence but these companies have a long history of producing returns for investors and due to their size, they are unlikely to go out of business any time soon. What’s more, these two companies both support dividend yields that are several percentage points above the income offered by most savings accounts.
The bottom line
Overall, if you want to achieve financial independence, a disciplined approach to saving is required. And the best way to ensure that you get the most from your money is to separate your funds into different buckets, with different levels of risk and reward based on your own financial circumstances. Job done.
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Rupert Hargreaves owns shares of GlaxoSmithKline and Royal Dutch Shell B. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline. The Motley Fool UK has recommended Royal Dutch Shell B. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.