By Guy Baker, CFP®, MBA, MSFS
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In the investment system I espouse, there are three distinct categories or tiers of investments: conservative, growth and speculative/aggressive.
The conservative category is for your core dollars or “dear” dollars, those dollars you do not want to lose under any circumstances. This is your emergency fund.
The growth dollars refer to capital you are willing to allocate to long-term growth investments, and the speculative dollars are for high-risk investments. Investing speculative dollars is how you can really grow your wealth, but this category is also where you can lose it all.
By understanding the risk elements associated with each level, you can formulate a game plan—an investment strategy or investment policy statement. Let me illustrate how simple the administration of this idea can be with a metaphor: buckets of sand.
Imagine you are at the beach and have four buckets, in different sizes from small to large. Using the smallest bucket, No. 1, you scoop sand from the beach and begin to pour it into a larger bucket, No. 2. As you continue to pour sand, bucket No. 2 will ultimately fill and overflow. Sand will cascade over the side and back onto the beach.
However, if you place a larger bucket—No. 3—below bucket No. 2, the overflowing sand will instead begin to fill that one. Your buckets are transferring wealth from your conservative bucket to your growth bucket, much like the way sand moves in an hourglass. The sand builds up in a perfect cone as it trickles from one side of the hourglass to the other, ultimately flattening out as the final grains trickle through. It is a closed system. No sand is lost.
The key to your wealth buckets is to not allow any of the sand to fall back on the beach. You need to carefully fill your buckets and transfer the excess to the buckets below.
As the sand in bucket No. 3 fills up, it will cascade over the edge to a larger bucket waiting below. This is bucket No. 4, and it holds your most aggressive assets. When you have completed the cycle, you will then increase the size of your buckets.
This systematic transfer of sand from the initial container into the second, third and finally the fourth bucket is a great example of how a systematic investment program works. This is the three-tier system of investing.