The Bucket Strategy
A retirement bucket strategy is a way to plan for retirement by dividing your money into different buckets. It is a good idea to use this strategy if you want to have control over the allocation of your assets and the timing of your withdrawals.
The idea behind this strategy is that you need to divide your assets into different types of investments and then invest in each type accordingly. This will help you achieve diversification and minimize risk.
The bucket strategy seeks to create a paycheck from your investment assets assuming we’ll always need to spend the cash in one bucket to make ends meet, while the other buckets appreciate and collect returns while staying liquid.
A diversified pool of long-term holdings is used for assets that are not needed for several years or more. The cash buffer in the first bucket provides peace of mind when periodic downturns are seen in the long-term stock portfolio.
Bucket #1 – The Cash Bucket
The cash bucket is key to this strategy. It must be highly liquid to meet near-term living expenses for one year or more, typically one to three years.
Cash yields are usually extremely low. At the time of writing this article rates are on average .05 percent so definitely don’t think high returns for Bucket 1. The goal of this bucket is to have stabilized principal that meets the immediate income needs not covered by other sources.
So, how do you figure out the amount of money to hold in Bucket 1? You should start by listing out your spending needs on an annual basis. Go deep into your current spending transactions and be honest with yourself on what expenses will stay around once you retire.
The number you come up with will be the amount of annual income needed for Bucket 1. A conservative investor is one who invests with the least amount of risk. If you’re a conservative investor you might want to pad the Bucket 1 cash holding amount and multiply by 1.5 or 2 to better ensure you’ll have enough.
On the other hand, if you’re concerned about putting too much cash in Bucket 1 and missing out on potential gains you might consider building a two-part liquidity pool–one year of living expenses in true cash and one or more year of living expenses in a slightly higher-yielding alternative holding.
You might also consider having an emergency fund within Bucket 1 for unanticipated expenses like car repairs, additional healthcare costs, and so on.
Bucket #2 – The Income Bucket
This bucket contains five to eight years’ worth of living expenses, with a goal of income stability and growth. This bucket includes bonds, longer-term certificates of deposits, REITs, and dividend-paying stocks. Balanced or conservative index funds would be appropriate in this part of the portfolio.
This bucket of money can be used to refill Bucket 1, as those funds are being depleted.
The investments in this bucket have moderate risk but offer some return when compared to Bucket 1.
Bucket #3 – The Long-Term Growth Bucket
Bucket 3 has the longest-term outlook of all the buckets in your portfolio. It’s dominated by stocks, commodities, alternative investments, and junk bonds which are more volatile. You may have to maintain this portion of the portfolio with periodic trimming to prevent it from becoming too heavy in equities. This Buckets asset allocation is more likely to produce the strongest long-term performance.
But because these assets have a greater risk, this Bucket will have a much higher potential for losses than Bucket 1 and 2. Buckets 1 and 2 are in place to minimize your losses when Bucket 3 isn’t doing so well. It’s easy to withdraw cash from Bucket 1 or 2 rather than pull it out of Bucket 3 when it’s struggling which would just turn your paper losses into real ones.
The investments in this bucket have high risk but offer higher returns when compared to Bucket 1 and 2.
Over time you will need to maintain your bucket balances. This doesn’t have to be overly complex and it’s recommended to not make too many changes that trigger capital gains hit.
Here are a couple of recommendations:
Refill Bucket 1 from Buckets 2 and 3 with the dividends and interest earned in those buckets.
When there’s a Bull Market sell some stocks from Bucket 3 to refill Bucket 1 and 2.
Conclusion & Helpful Resources
In this article, we have explored the bucket strategy and its benefits. The Bucket approach to retirement-portfolio management is a great way to protect your assets from volatility. The approach effectively helps you create a paycheck in retirement from your investments that can then be used for monthly expenses or other purposes.
Here are a few helpful resources about bucket strategy if you want more information on how it works.