What I often see in my practice is that someone/a married couple will come into my office …and the story will be something similar to them saying they have put their heads down worked a long career, saved & invested diligently over that time, and as they were getting close to retirement they finally picked their heads up to take a look around at their situation….what they end up seeing is that their saving and investing has amassed to a nice size nest egg. But it’s at THIS moment questions start to pop in their head or come my way…because what they are doing is going from the accumulation phase of their lives to the distribution phase of their lives.
Now at this transition from career mode to retirement mode, there’s a few things happening:
1) your financial objectives are changing. In your career, your objective was “I have to save enough to retire” . In retirement the objective changes to “will the money I saved last through my retirement?”
2) your time horizon is changing. In your career “it's I have until my planned retirement date to save enough money” in retirement it's “I need this money to last the rest of my life but I don't know how long that will be.”
And 3) your asset allocation comes into question… while you were in this career it was “My Portfolio is optimized for growth”. In retirement, it's “I have to decide how much I can safely take from My Portfolio to use his income
So in today’s blog, I want to talk about an investment/retirement planning concept that can be used to answer these questions. That is the “bucket approach” some people call it the “bucket strategy”. This strategy could be a game-changer for how you think about and use your retirement savings. we’ll talk about the basics of this approach, how you build your buckets, and finally how to maintain your buckets…
Understanding the Bucket Approach
Before I get into the how-to’s of this bucket approach, it's essential to understand the what and why of the Bucket Approach. At its core, this strategy is about breaking down your investments based on when you'll need them. Or.. said a different way…This method of retirement planning involves segmenting retirement assets into different 'buckets' based on when you anticipate needing them.
Pretty much everyone is familiar with dividing investments based on risk – like conservative, balanced, or aggressive…which is the principle of asset allocation – the Bucket Approach simply adds another layer into that principle: timing. Instead of just thinking about risk and reward, you need to consider when you’ll use the money."
so the bucket approach is a method of separating pots of money earmarked for different phases of retirement. Early retirement adventures, mid-retirement needs, and long-term security—all get their own buckets. At the end of the day this approach brings clarity, reduces anxiety, and offers a sort of high-level visual roadmap for retirement income planning.
Okay that cover’s the WHAT The bucket approach is but let’s just touch on the WHY for a minute as well. Because this is very important.
There are a few reasons why this approach can work well in retirement income planning, but The main “why reason” I like it…is that it helps protect against what is called the Sequence of Returns Risk. Now I’m not going to go in depth on this topic right now as it could take a whole other episode.
A quick explanation of this risk says that despite having solid average returns on your portfolio over your retirement years if bad returns show up early in your retirement WHILE you’re taking out of money for income can be detrimental to a retirement portfolio. Falling asset values combined with withdrawals that are too large can decimate a portfolio quickly.
Building Your Buckets
"Now, let's roll up our sleeves and discuss how to construct these buckets."
The Short-Term Bucket
The linchpin of this Bucket approach is a highly liquid component to meet near-term living expenses for 2-3 years. This bucket is by no means meant to be a return engine or a growth engine. The goal of this portfolio sleeve is to stabilize the principal to meet income needs not covered by other income sources.
Therefore to figure out how much to put in this bucket you first have to know what your spending or budget habits are on an annual basis. Subtract from that amount any nonportfolio sources of income such as Social Security or pension payments. The amount left over is the starting point for this short-term bucket: That’s the amount of annual income Bucket 1 will need to supply
Prior to the last 12 months, I was totally fine with this bucket of money literally making $0. Now there are money market mutual funds or short-term bonds that can give an attractive yield as of me writing this episode. But I’m not as worried about that as I am the protection of principle because this bucket will therefore eliminate the need to sell investments during market downturns early that is it’s main job
The Intermediate Bucket
This bucket funds the heart of your retirement, covering expenses in the 5-7 year range. While it still prioritizes safety, it allows for a bit more risk for potential growth. Sometimes people get mixed up that this bucket is “for” 5-7 years from now, which is kind of true however the best way to do it is to put 5-7 years of “Expense need” in this bucket
The Long-Term Growth Bucket
This is your growth engine, reserved for expenses ~10 years down the road. It's your buffer against inflation therefore the allocation is more aggressive than the other 2 buckets.. This portion of the portfolio is likely to deliver the best long-term performance, but this portion of the portfolio will also have much greater loss potential than the short term and intermediate term buckets.
And that is why the three bucket approach will help prevent any investor from tapping this growth bucket when it’s in a slump, which would otherwise turn paper losses into real ones.
Maintaining and Adjusting Your Buckets
"Alright, you've set up your buckets. But how do you ensure they serve you well over the years?"
Regular Reviews and Rebalancing
Just like any strategy, the Bucket Approach isn't a set-and-forget one. The main “maintenance” this approach is going to have over time…if you haven’t been thinking about it already is…. Refilling the buckets... How do you do that part. How do you keep the short term bucket filled after the ~ 2 years of retirement has gone by.
Well, you can’t just use a formula like “rebalance” every two years because what if the markets are down on that 2nd year? For example, 2022 saw stocks and bonds down double digits + … so You would then be selling holdings at a loss which is exactly what this approach tries NOT to do.
2022 was also a good example of why you should look at investment portfolios that diversify (above and beyond just stocks and bonds).
Having a game plan or guideline such as deciding you will not refill the buckets after any year that the stock market is down, but if the stock market is up, you will refill them all.
Or if the market is down, no refilling. You now have one year of cash and five years of TIPS
I’d stress this is the most important part of this strategy, the ongoing review. Setting it up is relatively straight forward. However, keeping it going is going to take regual reviews to ensure that your investments align with your evolving needs and market conditions.
So to review and wrap things up… We dove deep into the Bucket Approach today, and I hope this episode gave you with a better perspective on how you can structure your retirement assets. Remember, it's not just about the accumulation; it's also about making sure your hard-earned money is effectively structured for distribution throughout your retirement.
In my previous blog, "Cracking the Retirement Code: How Much Do You Need to Retire?", I discussed the three major stages of retirement: Go-go, Slow-go, and No-go. Connecting that with today's topic, think of the Bucket Approach as a strategic roadmap that can align with these stages. The Short-Term Bucket could support the active Go-go years, the Intermediate Bucket for the Slow-go phase, and the Long-Term Growth Bucket to ensure you're safeguarded during the No-go stage and beyond.
By meshing the insights from both these episodes, you can better visualize the importance of not just saving a sum for retirement, but also organizing that sum into thoughtful categories to ensure you don't outlive your money. Whether you're just embarking on your retirement planning journey or reassessing your strategy as you near retirement, I encourage you to take that extra step in planning, use the advisors in your corner, reach out to me if you don’t have any, but don’t think you have to navigate the financial uncertainties of retirement alone.
That’s it for me today, thanks for reading and until next time…be well