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Using Mental Accounting to Organize Your Financial Resources

by Michelle Cross, CFP®, CPA, CDFA®, AIF®
Allegiant Wealth Advisor 

Balancing multiple short and long-term financial goals can be overwhelming, especially when it's not something that you're particularly interested in. There always seems to be something more "important" (or perhaps more pressing items) requiring your time and energy.

However, besides health, there is nothing more important than securing your family's financial future. The concept of creating a "bucketed approach," or said another way, using mental accounting, to organize your financial resources may help you understand how you are tracking towards various goals and empower you to make decisions now that you won't second-guess or regret down the road.

When Allegiant's Wealth Advisors talk with our clients about their goals, we almost always talk about using mental accounting to allocate different buckets of money for specific purposes.

For example, retirees whose living expenses exceed their pensions and Social Security, generally will need to withdraw from their investments to bridge the gap. If you think back to Investing 101, you'll remember that the fundamental goal is to buy low and sell high. If you don't have enough cash on the sidelines to bridge your income gap, then you could be forced to sell investments to generate that cash, potentially when the market is down. Selling "low" is essentially locking in losses and preventing those investments from recovering when the market picks back up again. Therefore, we advise that it's important to have 1-2 years of planned withdrawals from your investment accounts set aside in cash or cash equivalents.

Since these retirees are regularly withdrawing from their portfolios, they need to invest in income-producing securities in order to backfill the cash that is being depleted. For this bucket of money, they should look at stocks that pay consistent dividends as well as bonds which pay interest. Dividends and interest should not be reinvested but instead, directed to cash so that it is available when needed.

There is also a need to invest differently for longer-term money. While inflation has been generally low for the past several years, there are certain goods and services whose cost is rising well above the Consumer Price Index (CPI). Examples include healthcare and college. In order to meet your needs for these and other expenses in the future, it's important to earn enough of a return to outpace inflation over time. As such, looking at investing in more growth-oriented securities such as stocks that don't pay a dividend but instead, reinvest their capital into the business, may be a place to meet this objective.

Another aspect or "bucket" worth paying attention to is the type of investment accounts you can draw from. If you have money spread across regular brokerage accounts, traditional IRAs and Roth IRAs, you have a choice in where you pull money from when you need to bridge your income gap. Generally, we think Roth IRAs are "assets of last resort" because the owner is not required to take distributions during his/her lifetime. Therefore, those assets could theoretically be invested more aggressively, for long-term growth. For retirees who are not yet of RMD age (delayed from 70½ to 72 through the passing of the SECURE Act), they may prefer to continue deferring taxes on traditional IRAs and pull from regular brokerage accounts to meet their current needs.

If you take the time to think about your money, both in terms of current needs as well as future considerations, many of us naturally gravitate towards using the philosophy of mental accounting. Personally I have found that this "bucket approach" provides Allegiant clients a clearer big picture perspective and ultimately makes them feel more confident that they will be able to meet their short-term and longer-term goals.

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