"Bucketizing" is not a word that can be found in English dictionaries so let me explain the term. I have coined the term "Bucketizing" for the process of allocating dedicated investments to a particular financial goal. For example, an individual may buy a Child Plan that provides both insurance as well as funds for the child's education when she turns 17 years old. Similarly, there may be dedicated investments for one's retirement plan. Hence, an individual plans by creating "Investment Buckets" for her various financial goals. The approach does have some advantages but also leads to sub-optimal allocation to investment options.

Advantages

The "Investment Buckets" may provide a more disciplined approach of investing and building wealth for an individual. As each "bucket" is linked to a financial goal, the investor will typically be reluctant to dip into that "bucket" and create a shortfall for the goal. The investor can simultaneously be conservative for a sacred goal and be aggressive for a nice to have goal. This style of investing suits well for passive investors who may not have the skills to do complex analysis on markets, risks, returns, asset correlations etc. They will also not have adequate time to monitor their investments on a regular basis. The investors rely on every scheme's manager to provide them with the corpus needed for each goal.

Disadvantages

The "Investment Buckets" create a sub-optimal allocation of money to various investment options. The investor will be bound to the performance of the funds that a particular "bucket" will be offering. Since there is a lock-in period in most cases, the scheme managers have less incentive to outperform the market. The many "buckets" increase the fees, the transactions and the administration charges on the overall portfolio of the investor. The twin effect of mediocre investment options and higher charges require an individual to invest more money to achieve her financial goals. For example, if an investor needs 50 lakhs for a goal in 20 years' time, she will need to save Rs. 5054 every month if she gets 12% annualized return on her investments. However, the saving will need to be increased to Rs. 6584 every month if she gets 10% annualized returns. The total savings required in the 12% and 10% cases are Rs. 12.1 lakhs and 15.8 lakhs respectively. The investor needs an additional Rs. 3.7 lakhs to cover the shortfall due to lesser returns.

The chances of overlapping investments or investments without consideration of overall portfolio risk increase significantly with the "Investment Buckets". The correlation between asset classes is not factored in as the providers are typically different for different schemes. For example, two "buckets" may have highly correlated investments which mean that both the goals will be in jeopardy if the market moves in the negative direction. This again results in lesser returns for investors sometimes as much as 3-4% and mismatched volatility of the portfolio.

The dedicated schemes "buckets" are typically mis-sold by the providers by exploiting on the emotions of an individual. For example, Children Education Plan is dear to everyone's heart and a sub-standard, high fees product can be sold to gullible investors easily.

Alternative

Individuals do have an alternative by considering financial goals in the context of overall portfolio, its return, its risks and correlation amongst the underlying asset classes. The exercise should involve developing a comprehensive financial plan which can de-risk the portfolio by appropriately risk-profiling the client, identifying the minimum required return, building some cushion in the plan and monitoring the status on a regular basis. The implementation of the plan in terms of actual investments has the flexibility of making amendments based on the ongoing performance of the portfolio.

Mitraz Financial in its financial planning approach advises two "buckets" - Short-Term and Long-Term Assets for its clients. The Short-Term Assets are available for next 3-6 months of expenses and committed investments and next one year's goals requirements. The returns assumed on Short Term Assets are quite small. The Long-Term Assets build an individual's wealth over a period of time and can be invested according to the asset allocation suitable for the risk profile determined and required portfolio return. With regular monitoring, Mitraz advises clients to move assets from Long-Term to Short-Term as per the details captured in the comprehensive financial plan. This ensures that investments are exited considering opportune market time and the investor does not have to resort to distress sale to meet a financial goal. The approach of Short-Term and Long-Term Assets provides an optimal allocation of money while keeping the short-term cash flow needs in mind.

The writer is the Managing Director of Mitraz Financial Services Pvt. Ltd and can be contacted at micontact@mitraz.financial