Using “buckets” or multiple portfolios isn’t a new idea. I’ve seen it used for various purposes. The premise is pretty simple but proper use can be very powerful and financially rewarding. Rather than creating one portfolio that is set to mature when you reach a certain age, let’s say 65, create multiple portfolios with different target or maturation dates.

Let me explain using my wife and I as an example. Normally, a couple spends all of their working years putting money away into 401Ks and IRAs with the goal of retiring at age 65. Due to tax laws, we can’t touch the money in those retirement accounts until we reach at least age 59 1/2. So we dutifully invest money for 40 years. As youngsters, we invest aggressively because our time horizon is long and we can afford to have years with losses. But as our retirement date approaches, we move more and more money into safer investments. So our portfolio makes less money as we get closer to retirement. And yet, with the high life expectancies of today, this one portfolio will have to be sufficient enough to last us 20-30 years. But if we are only earning 3-4% each year, then we may run into trouble.

Now let’s consider using multiple buckets or portfolios. We’ll start with just a simple two bucket or portfolio approach. In this example, I expect to live 30 years after I retire at age 65.

• Portfolio 1 contains only one half of all our retirement money and is designed to be available the day we retire at age 65. So again, we slowly move money into safer investments as that day draws near. BUT, we only want this portfolio to last 15 years and then run out.
• Portfolio 2 contains the other half of our retirement money and is designed to be available when I’m 80 years old and the first portfolio runs out. Since I have an extra 15 years to invest this portfolio, I can be aggressive for much longer and earn more money before having to move to safer investments such as bonds.

So the benefit is that through using multiple portfolios, I can be more aggressive where possible and increase my potential return. Now, let’s get a bit more fancy again using my wife and I as an example.

• Portfolio 1 uses only normal, taxable accounts because I want to retire at age 50. So I need to withdraw from accounts where I don’t face tax penalties for early withdrawals. But I only need this account to last 10 years because then I can access my tax deferred (401Ks) or tax advantaged (Roth IRA) accounts.
• Portfolio 2 uses tax deferred or tax advantaged accounts and is designed to mature or be ready to use when I turn 60 and Portfolio 1 dries up. In our case, I want that account to last until we are 70.
• Portfolio 3 may use a combination of taxable and tax deferred accounts because I intend to draw every penny out of it in my 60th year in order to build our retirement home (we plan to do a lot of traveling in our 50s).
• Portfolio 4 is invested more aggressively for longer than any other account because I don’t need it until I’m 70. But then I intend to use this account until the day I die. So it has to last for 20 years.

This may seem a bit absurd or overboard, but so does coupon-ing until you try it and see the cost savings. The goal is to maximize the time that you have and the return that you can earn on your money. Don’t just make your money work for you, make it work smarter for you.

Understand, though, that this bucket approach is a numbers game. Meaning, you have to crunch a lot of numbers to determine how much money needs to be in each account on the day it is supposed to mature or be ready for use, how much money you need to put into each portfolio on a monthly or annual basis, and how much you need to be earning on average in each portfolio in order to meet your goals. So if you are not comfortable running the numbers yourself, please consult a competent financial advisor. I’m a strong advocate of hiring a professional if you need the help.

For a few ideas on selecting an advisor, you can read our post titled 5 Tips for finding a good Financial Planner.

Hopefully I’ve adequately explained the bucket approach well enough that you have at least an idea or inkling of its potential. Please feel free to ask any questions or provide suggestions to others in the comments section below.

Also, you can follow Rabbit Funds on Twitter for more investing and retirement ideas.

Looking for post ideas, I asked my Facebook community for suggestions. The first response I received was, “How do I know if a Financial Planner is any good?” Others immediately chimed in that they would also like know.

So I’ve spent some time compiling criteria for selecting a financial planner for a number of sources, including financial planners themselves.

Desire to learn and teach

This habit is straight from the horse’s mouth.

“The desire to learn and teach is the most important. For a planner to be effective, he/she must constantly be studying new laws, products, strategies, and a million other things. But to really do the best thing for the client, a planner should teach each client as much as reasonably possible. Essentially, arm the client with enough information so that he/she can recognize good ideas and learn to avoid the bad ones for his or her individual situation. Teach the client to develop good financial habits, and help them develop the savvy to ask good questions.”

Here are a few questions to ask a potential planner to find out whether or not they are still learning.

1. When was the last financial planning related course you took and what was it?
2. What trade journals do you regularly read?
3. What and when are your most recent certifications?

Strong educational background

Several years ago, when I was still in school and studying financial planning, I was approached by a firm offering a financial planning position while I was still in school. Not really knowing what I was signing up for, I joined and started going after my warm market. After a short time, I realized that this firm, and others like it, use a poor approach to recruiting new planners. Basically, they convince individuals who are looking to switch careers or need money or like planning or whatever reason, teach them a little bit about financial planning (focusing on variable universal life insurance), and set them loose on the population.

There is one huge flaw in this approach – the new recruits don’t know anything about financial planning except for the few, specific things they are taught in a very short time. I understand learning on the job. But sending an army of good intentioned newbies with no real educational background out to sell products to individuals who know even less does not end well.

So verify how much education your planner has in varying areas of financial planning.

Strong experience

I was tempted to combine this attribute with the prior one. However, I believe it merits its own lime light. Ask your planner or potential planner the following questions:

1. What licenses do you have?
2. How long have you been licensed and practicing?
3. Who are three current clients that I can contact?
4. Why did you lose your last two clients? (The manner in which a planner responds to this question is almost as valuable as the answer itself)
5. How much money/assets do you have under management right now?
6. When you are unsure, who do you consult with or call?
7. Do you use partners for estate planning, tax planning, investment planning, and insurance planning? And if so, who are they and can I speak with them?
8. Pose specific situations and ask how the planner would address them.

Understand that you are hiring a planner and that he or she should go through the same rigorous interviewing process that you would implement for a high level CFO. Your planner is your CFO and you will regret not spending enough time hiring the right one.

Fee based versus Transaction based

I hesitate a little to even broach this topic. I do not intend to make a case for one or the other. Rather, I just want to explain some of the issues surrounding how the financial planner is paid.

• Transaction based financial planners are paid by the investment or insurance company every time there is a transaction or sale of a new product. Meaning, you do not pay anything to the planner (big plus). However, the planner may have the incentive to move you from investment to investment in order to generate additional income (called “churn”) or direct you to products with big commissions.
• Fee based financial planners are paid a set amount by you to perform specific tasks or take a percentage of the value of your holdings each year. For example, I may pay a fee based planner $2,500 to evaluate my finances and create an investment strategy. The purpose of the fee is to create an objective plan. If I choose to have the planner open the accounts and make the investments for me, then he or she will receive a commission from the investment or insurance company. Or I can open the accounts myself. With percentage based planning, the planner has an incentive to grow my assets each year since the dollar amount of the fee corresponds to the overall size of my portfolio. In other words, if my portfolio grows, the planner makes more money.

Longevity in the industry

The financial planning industry experiences a very high turnover rate. The first five years are the most difficult and about 90% drop out. You don’t want to sign up with a planner that will be out of the business in six months.

So look for a busy planner with a secretary or assistant that has been in the industry for more than five years. Since assistants are paid for out of the planner’s own pocket, having an assistant usually is an indicator that the planner is both successful and serious about staying. Though anyone can hire an assistant. So also look for planners with at least five years experience.

What other factors do you find to be important when selecting a new financial planner? For more tips and commentary on financial planning, follow Rabbit Funds on Twitter.