DEFINITION of Bucket

Bucket is a term in business and finance related to the grouping of assets or categories. Buckets can receive risk assets such as equities, lower risk or risk-free assets such as cash and short-term securities, fixed income securities with similar maturities or swaps or derivatives with proximate maturities. In managerial accounting, cost buckets are created to track unit-level costs.

BREAKING DOWN Bucket

A bucket is a casual term of portfolio managers or investors for grouping of assets. A 60/40 portfolio represents a bucket of 60% stocks and 40% bonds, for instance. A bond-only portfolio could be segmented into buckets of 5-year, 10-year and 30-year maturities. An equity portfolio could have a bucket of growth stocks and another bucket of value stocks. Buckets can be used to assess the sensitivity of a portfolio of swaps to changes in interest rates. Once risk (called "bucket exposure") has been determined through a process called "bucket analysis," the investor may choose to hedge that risk if it is cost-effective to do so. A strategy called immunization can be used to create a perfect hedge against all bucket exposures.

Nobel laureate James Tobin developed a strategy called a "bucket approach" for investing, which entails allocating stocks between a "risky bucket" to produce returns and a "safe bucket" to meet liquidity or safety needs. To Tobin, the composition of the risky bucket would have little or no effect on overall risk assumed by the investor as long as the investor held two buckets. Instead, changing the risk level would be achieved by changing the proportion of funds in the risky bucket relative to the safe bucket. Tobin's approach is simple and elegant, but some proponents of the bucket strategy recommend using up to five buckets.

In managerial accounting, direct material, direct labor and overhead costs are placed into cost buckets for different products manufactured by a company. A cost bucket for Product X would contain each of the three cost categories as would Product Y. Managers would then be able to better estimate unit-level costs of the products.