By John Wasik
CHICAGO, April 16 Got travel or mountain
climbing on your bucket list? How about taking up the guitar? If
you really want to live life to the fullest in your remaining
days, then what you should also add to those goals is a list of
your investment priorities and adjusting your risk accordingly.
This idea doesn't come from a cheesy Hollywood movie, but
rather from the study of behavioral portfolio theory put forward
by Nobel Prize-winner Harry Markowitz and leading behavioral
economics expert and finance professor and author Meir Statman
(). They theorize that if investors
divide their portfolios into mental account layers measured by
risk, they can counter nervous investment errors.
This is how it works: let's say you have a $1 million
portfolio. You can divide it up into different-sized buckets
with goals for items like college savings and retirement. For
* The largest bucket, or sub-account, would be for
retirement. Assume that about $800,000 is in this bucket for an
event that's 15 years away. Ultimately, you would like to build
this to $2 million.
* Saving for college? Earmark $150,000 for a goal that's
three years away, eventually totaling $180,000 when your student
* Want to fund a bequest for your alma mater or your
favorite charity? Put aside $50,000 for a goal that's 25 years
If all of these goals were equal - and they are not - you
might leave them in one portfolio. However, you want to take
much less risk with the college fund than with the bequest goal
that is 25 years away.
By marking each bucket high, low or medium risk, you've
identified some prospective allocations in this behavioral
approach. In this case, risk is roughly equivalent to the time
you have to save for each goal. The shorter the time horizon,
the lower the risk you can assign to the bucket.
The short-term bucket should be invested mostly in bonds or
cash equivalents in which you cannot lose principal. This is
your most secure bucket and it's for goals such as saving for a
down payment on a home or a car, or to set aside money for a
known expenditure like property taxes. Don't expect much, if
any, return on these funds. Federally-insured money-market
accounts, Treasury bills and certificates of deposit are
probably the safest assets.
The medium-term bucket can be for major emergency expenses
such as unemployment and out-of-pocket medical expenses. I keep
that money in a short-maturity bond fund. It's not
principal-protected, but it pays a somewhat higher return than a
A medium-term bucket is also a good place for college
savings. For the biggest chunk of college funds for my two
daughters, for example, I have money set aside in automatically
age-adjusted 529 savings plans. As they get older, the fund
company shifts more money from stocks into bonds. I like this
approach because the accounts are rebalanced every year, so I
don't fret about market risk. All I worry about is putting
enough money in to cover soaring education bills.
Your longer-term goals can be weighted more heavily toward
stocks and alternative vehicles. Again, you can choose an
automatic approach through a target-date maturity fund that
ratchets down stock-market risk as you age, balance your own
portfolio of low-cost exchange-traded funds or hire a fiduciary
adviser to select passive funds for you (the most expensive
As you create your bucket list, don't get tripped up by
things like projected or "desired" returns. Guess on the
conservative side - less than 4 percent for bonds and 6 percent
It's also important not to try to overthink your decisions.
Be flexible and try different scenarios. Use allocation engines
to guide you through determining a comfortable portfolio mix.
For some good calculators, see websites like those of Yahoo
Finance, TIAA-CREF or T. Rowe Price.
Any comprehensive financial planner who works on a fee-only
basis (no commissions) will be able to fine-tune your strategy
if your needs are complex. Brokers and insurance agents should
If you do this right, you'll be able to see a range of
investing possibilities that you may not see today. There is no
one right way to go about this, but if it is done with care, you
can avoid a leaky investing bucket.