Introduction
A bucket is a casual term used in business and finance to describe the grouping of related assets into several different categories. The categories can include high-risk securities, such as equity shares, or lower risk securities, such as short-term fixed-income bonds.
On the time-front, a bucket can consist of short-term funds that are easy to liquidate, medium-term funds that involve investments accessible in three to five years, and long-term investments that are typically planned for getting returns post-retirement, such as ten or twenty-year investments.
An investor uses the bucket approach to diversify his portfolio into different buckets with varying degrees of risk. For example, a 60/40 bucket would mean an investment where 60% invested in high-risk stocks, and 40% is invested in fixed-income bonds. A bucket can also be completely equity-based or bond-based, and further diversification between these categories may occur based on risk or time.
Who Invented the Bucket Approach?
The bucket approach was invented by James Tobin, a Nobel laureate. He proposed the allocation of investments between high and low-risk buckets, depending on the risk appetite of the investor.
Why is the Bucket Approach Important?
A bucket approach helps an investor assess and hedge risk. Hedging of risk is only done if it is cost-effective. Immunization is a strategy used, where a perfect hedge is created against all bucket exposures.
The bucket approach is similar to the concept of “not putting all eggs in the same basket”. This would help the investor stay invested, and not lose everything, even during poor market cycles.
