The Safe Investor teaches investors how to organize their savings into three “pockets”. This makes it easier for them to budget their savings and investments into three categories: savings, investing, and trading. First, sit down with your financial advisor to discuss about a savings plan. Relevant information include your take home pay, monthly expenses, and a breakdown of what you spend on every month. Once you are ready to commit to putting aside some money periodically (usually monthly), then you are ready to put this money into the three pockets.
Below is a diagram of the three pockets: as seen on page 102 of The Safe Investor
The Savings Pocket has two objectives for. First is to not lose any principal. Second is to be liquid in case of any emergencies. Trade offs for the savings pocket is that cash sitting here will not have a real return.
The Investing Pocket is for true investments. This pocket is used to successfully minimize risks in a diversified portfolio. You and your financial advisor can decide which funds to invest in, while the book The Safe Investor, will expand on possible investments and recommended allocations. You will want to invest with a long term time horizon in order to capture compounding returns and further minimize risks of cyclical stock market activities. Meanwhile, the periodic deposits into this pocket will act as a buffer in order to lower the average price of your investments in case of a possible market bubble and crash.
The Trading Pocket is a psychological release valve. An investor that is constantly watching what the market does is also aware of popular trends and hot ipo issues going around. Rather than risk the majority of an investor’s capital, the Safe Investor can save and invest, and have a third account that is proportionately smaller in order to make these sorts of bets. This will keep any investor looking to make 15%+ returns satisfied.
Lessons of The Three Pockets:
- Savings Pocket is your “rainy day” pocket or for emergencies. This is short term money used for short term expenses.
- Investing Pocket grows more than your savings pocket but less risky than your trading pocket. The key thing is to diversify across a variety of asset classes, and across many country types and geographies. Use time in order to trickle in your investments.
- Trading Pocket helps to alleviate your brain’s response to either panic when the market goes down, or become greedy when the market goes up. With this account, you can go ahead and make concentrated bets on stocks.
Information taken from The Safe Investor published by Palgrave Macmillan