What Is Bucketing?
Bucketing is an unethical practice whereby a broker generates a profit by misleading their client about the execution of a particular trade. Specifically, it refers to a situation in which the broker confirms that a requested trade has taken place without actually executing that order. The broker then attempts to execute the order at a more favorable price than the one quoted to the client. The spread between these two prices is then kept by the broker as profit, without revealing this fact to their client.
A brokerage firm that engages in unscrupulous activities, such as bucketing, is often referred to as a bucket shop.
Key Takeaways
- Bucketing is an unethical business practice in which a broker effectively steals from their client.
- Specifically, it involves lying to the client about the terms on which a trade was executed in order to profit from the difference between the actual and reported execution prices.
- Bucketing can occur with both buy and sell orders.
- Firms that engage in bucketing, or similar practices, are referred to as bucket shops.
- Bucketing can also refer to a retirement strategy used by retirees that involves dividing up their assets into different "buckets" and using them when needed.
Understanding Bucketing
Bucketing is an unethical business practice because it involves placing the broker's interests ahead of those of the client, while also misleading the client into believing that their interests are being given priority.
Effectively, bucketing works by exploiting the trust held by the client toward the broker. By placing their trades through the broker, the client is acting on the belief that the broker will seek out the best available terms when executing that trade. In the case of a buy order, this means obtaining the lowest price possible, while the opposite is true for a sell order.
In practice, however, brokers engaged in bucketing exploit this expectation by lying to the client. When processing purchase orders, they will tell the client that they have purchased the shares at a specified price, whereas in fact they purchased the shares at an even lower price and kept the difference as profit for themselves.
In the case of a sell order, the broker will tell the customer they sold at a given price when in fact they sold at an even higher price. In both cases, the broker pockets the difference between the actual price and the one communicated to the client. In substance, this amounts to stealing from the client's own profits.
Historically, the term "bucket shop" referred to any business that involved illegal or quasi-legal gambling. However, more recently the term has been used to refer to brokerage firms that engage in unethical practices, such as bucketing.
Special Considerations
Bucketing also refers to a retirement strategy whereby an individual divides up their assets into different "buckets" based on when they'll need them in retirement. This is opposed to the traditional method of receiving retirement income where a retiree receives regular distributions from their portfolio to cover expenses. The goal of a retirement bucket strategy is to ensure the retiree has enough money to last the rest of their lives.
For example, a retiree will have a near-term bucket with a specific amount of assets and only those assets will be used to help the retiree fund retirement expenses. The same would be for a medium-term bucket and a long-term bucket that would be used last, if at all.
Bucketing is also a three-step process of financial planning. An individual aims to reach all three buckets as part of a step-by-step process. The first bucket is creating an emergency fund, the second bucket is reaching financial goals, and the third bucket is for retirement.
Certified financial planner (CFP) Harold Evensky is credited with pioneering the bucket approach to retirement portfolio management. His two-bucket strategy includes a cash bucket that holds five years of retirement spending and a longer-term investment bucket consisting mostly of stocks.
Example of Bucketing
Steve is a broker who regularly engages in bucketing. He receives an order from his client, Linda, who expects him to place her interests first when executing her transactions.
Linda's trade request is to purchase 100 shares of XYZ Corporation at a price of $10 per share or lower. Steve responds shortly thereafter, claiming that the trade was executed at a price of $10 per share.
In reality, however, Steve lied to his client. Instead of executing the order at $10 per share, he in fact executed it at $9 per share. The difference of $1 per share was kept by Steve as his own personal profit without disclosing this fact to Linda. At a $1 profit per share on 100 shares, Steve pocketed $100. That is $100 dollars that should have benefited Linda, from whom he stole.
What Is a Bucket Portfolio?
The bucket approach to investing is a strategy that allocates assets into various groups within a portfolio. For example, a 60/40 portfolio might mean the investor has allocated 60% of their portfolio to stocks and 40% to bonds. If an investor decides to invest only in equities, their bucket portfolio might be allocated according to different types of stocks, such as value stocks, growth stocks, or dividend payers. A portfolio consisting only of bonds might have buckets for different maturity dates, such as short-, medium-, or long-term maturities.
What Is a Bucket in Accounting?
Accounting professionals often use the term "aging bucket" to refer to a group of unpaid receivables. A company's accounting department will track debts owed by customers according to the "aging bucket" or timeframe that the debt has been unpaid. They will place receivables in aging buckets of 30, 60, 90, 120, 150, and 180 days. Most companies will have a set of policies and procedures they will follow depending on how late their customers are in paying their debts. This may lead to a specific collections process or it may lead to the company writing the amount off as a bad debt.
What Is a Bucket in Banking?
This type of bucketing helps people manage their money by using multiple bank accounts. People who use this money management strategy will set up separate bank accounts (referred to as "buckets") earmarked for specific purposes, such as paying monthly bills, saving for entertainment or vacations, and emergency savings. They will automatically deposit a certain predetermined amount into each bucket every month. Some people who struggle to pay their debts or save for the future find the simplicity of this method to be easier than trying to use budgeting software or spreadsheets to manage their money.
