Retirement And Bucket Strategies: Smart Money Management?

The bucket strategy is a retirement asset allocation and spend-down strategy that aims to minimise the sequence of returns risk. It involves dividing your investments into three sections with various levels of risk over different timespans: one focused on short-term needs, another suited for mid-range needs, and finally an allocation designed for long-term needs. The bucket strategy is a powerful visualisation and organisation tool that can help you navigate market fluctuations while enjoying a steady source of portfolio income during retirement.

The bucket strategy was pioneered by financial-planning guru Harold Evensky and popularised by Ray Lucia's book Buckets of Money: How to Retire in Comfort and Safety.

Short-term bucket: Money needed in the next 1-4 years, typically in cash or cash equivalents

The short-term bucket of the retirement bucket strategy is designed to cover an individual's living expenses for the next one to four years of their retirement. This bucket is focused on low-risk, highly liquid assets, such as cash and cash equivalents.

Cash equivalents are short-term investments that can be easily and quickly converted into cash. They include bank accounts, money market accounts, certain marketable securities (such as commercial paper and short-term government bonds), and certificates of deposit. These investments have short maturities, typically 90 days or less, and are considered low-risk due to their high liquidity.

The short-term bucket ensures that retirees have readily accessible funds to cover their immediate living expenses without having to sell off their higher-risk, long-term investments during a potential market downturn. This allows the long-term investments to recover from volatility and compound over time.

The amount allocated to the short-term bucket depends on an individual's estimated future living expenses and other sources of income, such as Social Security or pension payments. Typically, this bucket is positioned to cover one to five years' worth of expenses.

By having a dedicated short-term bucket, retirees can safeguard their income needs in the present while maintaining access to a stable source of funds. This bucket strategy provides a predictable and stable approach to retirement income, making it easier to track progress and monitor one's financial situation.

Intermediate-term bucket: Money for years 5-10, invested in conservative to moderate-risk assets

The intermediate-term bucket is designed to cover expenses for years 5-10 of retirement. Money in this bucket should be invested in conservative to moderate-risk investments that can at least match inflation.

Longer-maturity bonds (2-10 years), longer certificates of deposit, preferred stocks, large-cap value stocks (dividend producers), income funds, and REITs are typically placed in this bucket.

The goal with the intermediate bucket is to match or very slightly outpace inflation without taking on significant risk to your investment principal.

The intermediate-term bucket is also known as the medium-term bucket. It is for money that you will need in the next five to seven years, and it is typically invested in bonds or a conservative mix of bonds and riskier assets. The idea behind this bucket is that it can be tapped in the event of a prolonged bear market where you have already exhausted the short-term bucket.

If you are a particularly risk-averse investor, you may prefer to make the intermediate bucket 7-10 years instead of five.

Long-term bucket: Money for 10+ years, invested in high-growth, high-volatility assets

The long-term bucket is the higher-risk portion of your retirement portfolio. Money in the long-term bucket is invested with an eye on a 10+ year time horizon, providing the opportunity for significant growth.

Growth stocks, small-cap stocks, emerging market stocks, high-yield bonds, and Nasdaq or S&P500 index funds would all belong in the long-term bucket. These investments are likely to provide continued portfolio growth over the long run, even though they are vulnerable to bigger swings in the short term.

One of the benefits of the long-term bucket is that, even though you might see big losses on paper during a market downturn, you can turn to the money in your other buckets, so you don't need to sell while prices are low. You have a smaller chance of taking a big loss. And, as the market improves, you can capture the gains later.

The bucket strategy works by pouring assets between buckets. The idea is that as you use money in your short-term bucket, you'll replace it as needed by selling assets from your medium-term bucket. Later, when growth assets are performing well, you'll sell a portion of your long-term bucket, capture the gains, and invest that money in assets that make up your medium-term bucket.

The bucket strategy is a powerful visualization and organization tool that can help you navigate market fluctuations while enjoying a steady source of portfolio income during retirement.

Customisation: The ability to customise the strategy to individual retirement goals and preferences

The ability to customise the bucket strategy to individual retirement goals and preferences is one of its key advantages. The flexibility it offers is greater than that of alternative drawdown strategies, such as the 4% rule.

The number of buckets, their respective risk levels, and the types of assets they contain can all be tailored to meet an individual's needs and preferences. For example, while the strategy typically involves three buckets, some investors opt for four or more.

The short-term bucket, designed to cover living expenses for the first few years of retirement, can be customised to hold between one and five years' worth of expenses. This bucket typically contains low-risk, liquid assets such as cash savings accounts, money market accounts, or short-term treasury bills.

The intermediate-term bucket, meant for the following five to ten years of retirement, can be adjusted to hold investments with moderate risk. This may include longer-maturity bonds, longer certificates of deposit, preferred stocks, large-cap value stocks, income funds, and REITs.

The long-term bucket, designed for money that won't be needed for at least seven to ten years, can be customised to hold higher-risk investments with greater growth potential, such as growth stocks, small-cap stocks, emerging market stocks, high-yield bonds, and index funds.

The ability to customise the bucket strategy allows retirees to adjust their portfolios based on their risk tolerance, financial goals, and desired investment outcomes. It provides a flexible framework that can be adapted to meet the unique circumstances of each individual.

Refilling buckets: The strategy's effectiveness depends on when and how buckets are refilled

Refilling the buckets is a critical component of the bucket strategy. However, the strategy does not provide a specific way of refilling the buckets.

One approach that works in most situations is to use cash holdings and fixed-income assets from buckets 1 and 2 (and possibly bucket 3). Then, focus on rebalancing the proceeds from bucket 2 and especially bucket 3.

The bucket strategy is designed to help retirees manage the competing goals of needing to pull cash out of a portfolio for monthly expenses and needing their investments to grow to support future spending and offset inflation.

The bucket strategy does this by creating "buckets" to hold cash, bonds, and stocks based on when you'll need to spend each bucket. Bucket 1 is typically made up of cash or similar investments where the nominal principal cannot be lost. Bucket 2 consists of money that will be used when bucket 1 is exhausted and is typically invested in bonds or a conservative mix of bonds and riskier assets. Bucket 3 is the riskiest and is for money that won't be used for 7-15+ years. It is invested aggressively in stocks and real estate.

When it comes to refilling the buckets, there is no one-size-fits-all approach. Some people choose to refill their buckets annually, while others do it more frequently. Some people only refill their buckets after a certain number of positive years in the stock market. Others choose to refill their buckets with cash holdings and fixed-income assets from other buckets.

The effectiveness of the bucket strategy depends on when and how the buckets are refilled. If buckets are refilled haphazardly or not at all, the strategy may not be effective in managing the competing goals of retirement spending and investment growth.

Frequently asked questions