Mastering Your Money with the Bucket System

People are inherently irrational. It makes life pretty exciting at times (to say the least!). Often, this means that we need to accommodate the way our brains work to increase our ability to succeed. One way we can do this in personal finance is to set up a “bucket system” to manage our money.

It’s simple to understand and set up, and you’re probably already using it to some extent. The bucket strategy is similar to the envelope system for spending but is more flexible and can be used for longer-term uses of money as well.

Mental Accounting and the Bucket Strategy

The bucket strategy is effective due to a psychological approach called mental accounting.

Mental accounting occurs when people compartmentalize money based on:

  • The source of the money (i.e. regular salary, bonus, tax refund, inheritance)
  • The intended future use of the money (i.e. daily spending, sinking funds, retirement savings)
  • How the money is spent (i.e. credit cards vs. cash)

If you have a basic budget (and especially a YNAB budget!), you’re already using the bucketing method. Dan Ariely, who has done extensive research into irrational human behavior, says the following:

“We need to understand that our spending decisions are often driven by emotions, not logic. By using mental accounting, we can create boundaries that help us make better financial choices.”

Dan Ariely

Budgeting money into categories (i.e., “buckets”) can provide the same benefits when applied to long-term saving and investing.

How Mental Accounting Helps (and How it Doesn’t!)

Let’s start with a few questions so that you can identify some possible ways you might be already using mental accounting:

  • If you overspend, does it “feel” the same to you if you have enough in your checking account to cover it as if you had to transfer money from savings to cover the overspending?
  • Do you have all your money in one account, or do you have separate bank accounts for individual savings goals and/or your emergency fund?
  • How many different financial accounts do you currently have in your name?
  • When was the last time you pulled money out of your retirement funds?
  • When you receive a bonus at work, do you spend more than your regular paycheck on discretionary spending (as opposed to regular bills, debt paydown, etc.)?
  • Do you spend your tax refund the same as other regular income?

As you’ve likely noticed, there are many ways you think about and organize your money that may not be purely rational.

Namely, you probably do spend “extra” money like bonuses and tax refunds differently from your regular paycheck. However, a tax refund is usually just your own money returned to you, which you would have received earlier if you had chosen to have fewer taxes withheld on each paycheck.

And, you’re probably saving for retirement in totally separate accounts from the ones you use for everything else (of course, part of this is due to tax savings!).

How Can You Implement This?

So, how can you use the way your brain thinks about money to your advantage?

First, it’s essential to get really clear on your financial goals. It’s easier to save money for the future when you have a clear picture of the life you want, rather than just saving money for some unknown future (yes, saving for “retirement” is still too vague!).

Next, assign the money you currently have available toward each of these financial goals.

Last, consider ways to effectively (either mentally, visually, or physically) separate those goals from other uses of money—especially everyday spending. This can be especially helpful in prioritizing unexpected “extra” income.

Some of the ways this can be done include:

  • Using a budgeting software that ties goals to budget categories, such as YNAB or Monarch Money
  • Set money rules to guide your spending (there is such a thing as saving too much at the expense of your current life). You can even specify how to use extra unexpected funds in your money rules. The key is to be intentional.
  • Using separate accounts for different goals, or better yet, using a savings account that allows for subaccounts (such as Ally Bank or Capital One)
  • Contribute to tax-advantaged accounts that help you save more for college, retirement, and medical expenses while also providing a substantial pain point (in the form of early withdrawal penalties) to discourage spending that money on other, less important things

By separating your money in these ways, you are more likely to reach your financial goals.

What Are These Buckets Anyway?!

Let’s examine some of the most typical “buckets” most people have in their financial plans. These fall into a few main categories, which we’ll explore in detail.

  • Current spending needs
  • Savings buffer to cover possible emergencies and/or job loss
  • Longer term goals
  • Retirement

This chart shows a breakdown of how these items might fit into various financial accounts.

Everyday Spending

Your day-to-day expenses include both fixed and discretionary costs such as housing, transportation, food, clothing, personal items, and other spending.

Of course, this money needs to be readily available, so it’s generally kept in a checking account (or often spent on a credit card, which is then later paid from a checking account).

Allocating too much to your everyday spending bucket and not enough to future goals is a frequent problem. However, it’s also not uncommon for people to struggle with spending money, even when they can (and should!). There’s definitely a balance, and having these funds separate can help in both situations.

Sinking Funds (including Taxes)

Generally, sinking funds refer to known expenses that either occur regularly but not on a monthly basis or that have an unknown time frame but are likely to occur at some point.

Some examples of sinking funds include:

  • Annual auto insurance and registration fees
  • Property taxes
  • HOA fees
  • Quarterly tax estimates (especially if self-employed)
  • Tuition payments
  • Holiday expenses
  • Home and auto repairs
  • Medical expenses (note that an HSA can be a great place to save money for future medical expenses)
  • Veterinary expenses

Most of these funds will likely have a set timeframe where you’ll need the money, so it’s often best to have them in a readily available savings account.

Emergency Fund

We all know we should have an emergency fund of at least 3 months of expenses. It’s important to understand what does and doesn’t qualify as an emergency.

An emergency is: a major auto repair, travel for an unexpected death in the family, or a job loss.

An emergency is not: regular auto maintenance, last-minute vacation, or variable pay that should have been planned for ahead of time.

Keeping an emergency fund in a completely separate savings account can help to ensure that it doesn’t simply become a buffer for overspending.

Dream Fund

Hopefully, you have numerous financial goals related to your dreams for your life. Really, this could be anything at all that requires financial resources. Some things you might save for in your dream fund include:

  • New car or home downpayment
  • Vacation/travel
  • Start a business
  • Save for a wedding

Keeping these funds in a separate account, or at least tracked separately, helps you ensure you are being intentional between spending money on fun things right now and your future fun.

College Funds

If you have children, you’ve likely either already started a college fund or at least considered starting one. Saving for college is often one of the biggest financial goals for parents.

A 529 is the most common way that people save for long-term college expenses. Because there’s a 10% penalty (on earnings only) if you pull money out for any purpose other than qualified education expenses, you likely won’t be pulling money out of this bucket for anything else.

Retirement Savings

While retirement shouldn’t be your only goal or maybe even your main goal, it just might be your biggest one. Fortunately, the government provides incentives in the form of tax-advantaged accounts to encourage saving for retirement.

There are numerous different types of investing accounts meant for retirement. These include a 401k, IRA, Roth IRA, self-employed retirement accounts, etc. Most of these accounts have a 10% penalty if funds are withdrawn before 59 ½, so there’s definitely an incentive to leave this bucket of money alone.

Bonus: Freedom Fund

In addition to your dream fund, you may want to consider starting a “freedom fund.”

A brokerage account provides flexibility to withdraw funds at any time (as compared to tax-advantaged retirement accounts), which makes it the perfect account for this purpose.

Final Notes

By acknowledging and working with (instead of against) your own irrationalness (that’s for sure a word…), you can find ways to more efficiently and effectively manage your money.

Remember, the key to financial success lies in setting clear goals, organizing your finances in a way that resonates with how you naturally think about money, and maintaining a balance between enjoying life now and planning for the future. Whether it’s everyday expenses, an emergency fund, or long-term dreams, categorizing your finances into distinct buckets can provide clarity and control.

How have you used the bucket system to help you achieve financial goals?


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I’m Kathryn Hanna-wife, mother of 3 and a Certified Public Accountant. I love to budget (really, I do!) , build spreadsheets and spend money on travel, sewing supplies and good chocolate.


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