The 3 Buckets Principle on How to Handle Your Money

With any client that comes into my office, I like to start off talking about what I call the “3 Buckets Principle” of money. It doesn’t matter whether they have $10 million in the bank, are just getting started on a financial plan, or right out of college in their first job. In my opinion, everyone should be working toward having their 3 Buckets set up.

While simple in its concept, the 3 Buckets principle helps make a complicated financial world and stock market seem much more understandable and visual. I’ve learned after spending over a decade trying to explain the complex financial world through so many words that the more simple and visual a concept is, the more likely one will adapt to the plan- it’s basic human nature. And the behavioral finance nerd in me loves the psychology behind this. Ok, drumroll…. the 3 Buckets are:

  • Bucket 1: Emergency Funds
  • Bucket 2: The Middle Bucket
  • Bucket 3: Retirement Bucket

Seems pretty simple, right? Then let’s get started.

Bucket 1: Your Emergency Fund

This first bucket is to help you out when the unexpected happens. According to Money Magazine, 78 percent of Americans will have a major negative financial event in any give 10-year period. (1) That’s a lot of people!

If that’s true, that means most of us will have one of those unfortunate events soon. You could lose your job, your car could break down, or you could start hearing the deafening sounds of a steady stream of water dripping from your living room ceiling. These are huge expenses that aren’t necessarily a line item in your monthly budget. This is when Bucket 1 comes into play.

Instead of dipping into your regular savings account or even worse, going into debt, you should fill Bucket 1 with enough money to cover these types of surprise events. But how do you save for the unexpected?

How Much Money Goes into Bucket 1?

My typical rule of thumb is to save three to six months’ worth of expenses. So when you’re calculating the amount for this first bucket, add up your rent or mortgage, all your bills and utilities, and an estimate of your basic living expenses like food and gas. For some of us, this monthly number could reach $10k or more. In a perfect world, I believe this should be set up and saved before you start thinking about any of the other buckets.

Now, I know how unattainable this bucket can seem especially if you’re just getting started with a financial plan and you’re digging your way out of debt. Please never feel ashamed of how long it may take to work through this bucket. We are a society that lives paycheck to paycheck, and it can take a lot of people 10 to 20 years to save their three to six months’ expenses. So know you’re not alone. Just do the best you can and keep working. This bucket is the foundation of any long term successful plan.

That being said, there are so many ways to help you get there. A guy with a lot of helpful tips for this situation is Dave Ramsey.

Dave offers a 7 Baby Steps plan to help people get control of their money. In his first step, he urges people to start saving for their emergency fund by doing whatever it takes. This could mean finding ways to cut back on your lifestyle, selling your car that you still make payments on to buy a cheaper car with cash, moving into a smaller home to cut down on bills and household items, or finding a quick extra job (can anyone say Uber?). Basically, do anything you can to build up those months’ worth of cash. (1)

You can find a list of Dave’s tips on how to save $1,000 for an emergency fund in one month here.

Where Should You Put Bucket 1?

The money in Bucket 1 should be easily available so that in case an emergency happens you can write a check or get your money that day. With that being said, the best places to keep Bucket 1 money are in a saving account at a bank or a money market account. It needs to be something that doesn’t fluctuate in the market so your funds will stay stable. The point isn’t to be making additional money off Bucket 1 and it’s not part of your long-term plan. Think of it as your “sleep at night” money.

Bucket 3: Retirement Fund

After telling my clients about Bucket 1, I like to jump to Bucket 3— your long-term savings bucket. This is a very simple bucket to understand as well as an important bucket for your future.

Bucket 3 is where you save for your retirement. Once you’ve got your emergency fund set up in Bucket 1, you can start putting 15 to 20 percent of your gross household income toward retirement. If you’re lucky enough to be at a company that offers a matching 401(k) plan, put part of your Bucket 3 money there. In addition to that or if you don’t have a 401(k) option, look into a Roth or Traditional IRA. A combination of these tax efficient vehicles will help develop Bucket 3. This money can afford to be invested more growth oriented, and more aggressive than Buckets 1 or 2 because it’s your longest term money.

This is also money you are likely getting tax benefits on, but you typically can’t touch it until you turn 59 ½ years old. Consider it illiquid- that means this is not money you use for bills or normal emergency situations. Only take this money out early if you are in the direst of straights because you could be hit with tax penalties, and taxes, for taking it out early. Many people were forced into this situation during the financial crisis in 2008. But, by building your Bucket 2, you can be prepared for the next financial crisis, whether it’s global, national, or personal.

So, simple as that, Bucket 3 is saving for your retirement.

Bucket 2: Mid-term Fund

When I’m talking to clients I always save Bucket 2 (“the middle bucket”) for last because it’s the one most people don’t have. Like we said earlier, it can take years if ever to get your first bucket set up. And that’s ok- you should take as long as you need to get there. But once you have that ready, it’s time to start thinking about shorter to mid-term goals. What do you want to be saving for and investing in right now?

If I have a client come to me and say “I don’t want my money just sitting in cash and doing nothing, but I also don’t want everything tied up in retirement while I’m in my 30s and 40s,” I’ll tell them it’s time to get their Bucket 2 filling up.

Bucket 2 is where you put money for your mid-term goals. That could be saving for your kids’ college fund, a down payment on a house, a rental property or just paying extra on your home loan to get it out of the way quicker.

There really are no boundaries when it comes to choosing goals for the funds in this bucket, so I’m often asked how much money should be set aside in Bucket 2.

The Bucket of Disposable Income

When a client comes in that I’ve been working with for while and asks where they should put new money I ask them:

  1. Do you still have Bucket 1 filled with 6 months’ worth of income?
  2. Have you been putting at least 15 percent of your earnings into Bucket 3?

If they answer yes, then I say anything extra can go into Bucket 2. This bucket can hold as much disposable income as you want. If you have Bucket 1 in place and are saving at least 15 percent of your income into Bucket 3, anything else should balance between your lifestyle and Bucket 2.

This is where the life-balance of “retire while you work” comes into play. Say you have $10k to do something with. First things first, immediately put your 15 percent in retirement. Then maybe you take some and go on a trip with your family, or you give some away and make a difference in someone’s life. Whatever you decide to do, make sure to put a chunk into Bucket 2.

The goal isn’t to save up so much money that you scrimp on everything in life. There’s no point of living on rice and beans and never taking a vacation with your family just to save tens of thousands of dollars for retirement. But you also don’t want to spend all your discretionary income and have nothing saved up for living later on. Everything in life, ultimately, comes down to balance and moderation.

Take 2008 for instance. Back when the market crashed, it’s safe to say that many people were not prepared for the drop in their investments, real estate holdings, or even a job loss. Without a Bucket 2 ready to go, many people went underwater with their homes and had to sell at a fire sale prices or had to cash out their 401ks.

Having Bucket 1 with your three to six months of savings set aside is perfect for most unexpected events, but if something like this happens again, you better believe another savings account to fall back on is a much better cushion then turning to credits cards and falling into deep debt. Also, if you have to use your Bucket 1 for an emergency, you can take some funds from Bucket 2 and replenish your emergency fund pretty easily.

Since this money is mid term money, it should be invested with what I call a balanced portfolio, where you “straddle the fence” between growth and conservative (think 50 percent stocks and 50 percent bonds for simplicity). That way, if the market goes down and you need to replenish Bucket 1 or need some of this money for a mid term goal, you have at least half in conservative investments and you don’t have to sell your growth investments while they are down.

Leave Nothing to the Unexpected

So there it is, a quick and easy way to understand where your money should be going. As with most things in life, the amounts of money and ways to get the 3 Buckets will look different for everyone. The point is to know exactly where your money is going and to keep you prepared for all of life’s unexpected surprises. This basic foundational plan can do wonders for you financially and emotionally.


  1. The Seven Baby Steps by Dave Ramsey

Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Any opinions are those of David Adams and not necessarily those of Raymond James. Please consult with your financial professional about your individual situation. Investing involves risk and investors may incur a profit or a loss regardless of strategy utilized. Raymond James is not affiliated with and does not endorse the opinions or services of Dave Ramsey.

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