- Michael DiBartolomeo
How Viable Is the Retirement Bucket Strategy in Today's Financial Context?
Retirement savings are not always enough to secure the financial future in today's world of wealth. Therefore, some people choose to opt for portfolio diversification, including fixed-income investments, more aggressive options for those with higher risk tolerance, as well as one or more alternative investments.
Bucket strategies can form a part of retirement planning as they are seen as a way of working towards financial freedom while playing things relatively safely. After all, when you do get to retirement age, you have competing concerns where monthly expenses and long-term planning are concerned.
You must be able to adequately address your spending needs, have an emergency fund, and still have enough money for whatever the future may hold. Assuming your personal finance was managed well, addressing your concerns during your retirement years requires withdrawals as needs arise. The idea behind the retirement bucket strategy is to provide a withdrawal strategy that can possibly preserve your nest egg.
While the strategy and its associated nuances are explained below, discuss the different options with a certified financial planner as you aim to either create or modify your retirement investing strategy.
Understanding the Retirement Bucket Strategy
The strategy helps retirees segregate retirement income into three metaphorical "buckets." Each has a dedicated purpose, which can be represented as short, medium, and long-term use.
When implemented well, the bucket approach allows you to have access to enough cash for your immediate needs, which means a lack of worry about short-term market fluctuations. Interest income, investment performance, and dividends are responsible for perpetually refilling your buckets.
Bucket One: The Immediate Bucket for Near-term Living Expenses
Liquidity is one of the defining factors of the initial bucket (the cash bucket). Here, your portfolio management strategy would see you including investments such as high-yield savings accounts, US T-bills, etc. that fall under the short-term umbrella. This bucket probably would not be seen as strong as a source of returns as the other buckets.
This portfolio is meant to help you keep your principal stable and meet your near-term needs. Cash and cash equivalents are prevalent here. To get started, you might do a bit of mental accounting and pencil out your annual spending needs. Deduct non-portfolio income from the figure this process yields. Such income sources include your pension, social security, etc.
What you're left with is what this bucket needs to cover. If you're more of a conservative investor, then you may want to multiply that value by two to stay on the safe side as you determine what you're typically going to need.
Bucket Two: The Intermediate Bucket for Stability and Income Production
The second bucket is where you factor in years three to 10 of your retirement. While the money here may not necessarily outpace inflation, it should at least keep pace. Still, you might not want to take on high-risk investments here.
Many investors ensure their portfolios include preferred stocks, growth funds, convertible bonds, utility stocks, etc. Again, this is where financial planners can help, as their experience with money market accounts, market volatility, etc. can help you to understand what kind of assets may be beneficial to invest in at this stage.
Income production and stability are the targets here. So, you find that more high-quality fixed-income investments dominate this bucket strategy. Nevertheless, a small number of high-yield assets may be present. However, keeping these types of investments minimal at this level presents numerous benefits such as effective management of loss aversion.
Should you manage this bucket effectively, it can be used to help you refill the first bucket as its assets become depleted.
Bucket Three: The Long-Term Bucket for the Stock Market and More Volatile Bonds
The last bucket, unlike the first two buckets, is where retirees can potentially outpace inflation, though it does not necessarily stand up to a market downturn as well as the other two would. Nevertheless, you grow your nest egg at this point, though it may come with the most risks.
You expect the assets here to be volatile in the short-term, especially with the number of down-market periods that may occur. Nevertheless, the expectation is that they appreciate over many years. You want your long-term bucket portfolio to include a diverse portfolio, containing stocks and other related assets. Additionally, there could be funds allocated to a local portion as well as an international portion.
Note that apart from smart asset allocation, you also want to carry out period trimming, since you don't want your growth bucket to be too equity heavy.
When implemented correctly, the bucket strategy allows buckets one and two to keep you from having to lose from tapping into bucket three while it's in a slump. If you do, then the cost can be steep since paper losses begin to become real ones.
The Importance of the Retirement Bucket Strategy
Don't look at the bucket strategy as a guarantee. As you know, once investments are in the mix, nothing is set in stone. However, with non-taxable and taxable accounts, considerations for living expenses, the need to maintain retirement savings and sustainable bank accounts, and more, it helps to have a strategy that you can use to invest and meet different requirements.
Without the division that the strategy creates, you may find yourself selling stocks, which are supposed to be long-term investments, in the short term. On the flip side, you may find yourself having retirement income that solely consists of non-inflation-resistant sources. So, your annual withdrawals for your living expenses, for example, seem to perpetually increase and reduce the spending power of your wealth.
A financial planner can help you to adequately create and maintain an immediate bucket, intermediate bucket, and long-term bucket, capitalizing on various elements such as cash flow, the stock market, fixed income assets, etc.
Concerns about the Bucket Strategy
Asset Allocation Challenges
One of the highlighted drawbacks of the bucket strategy is the way it ignores traditional asset allocation. Before proceeding, you should note that there is no single answer to how you should decide on the percentage equities account for in your portfolio.
However, historical data would indicate that the best option for most retirees is to have a portfolio that contains 50% to 75% equities. The allocations that bucket strategies use are not consistent with this. Only the last bucket concerns itself with growth potential heavily. The rest is more closely tied to retirement spending.
You may be perplexed by this analysis of bucket strategies considering you could review and rebalance buckets. However, you cannot use an overall balancing approach here. The reason is the way the bucket approach segregates retirement money.
The first two buckets are based on your retirement expense spend. The long-term bucket is not necessarily for spending, especially when markets are down. There's no way for you to be certain when a market is going to recover. If the discussion was about a bad stock market, rebalancing would include bond sales and stock purchases. However, you cannot achieve the same effect with the bucket approach.
Interest and Dividend Paying Stocks as a Part of the Investment Portfolio
Interest and dividends are often proposed to fill the gap where bucket refill is concerned. It sounds plausible because stocks and bonds (not exactly short-term bonds) from bucket three would help to produce the sed dividends. Additionally, bucket two helps to create interest, which can then be shifted to a retirees' first bucket.
The simplicity of this suggestion is its overarching flaw. It doesn't consider the full picture. Consider the results if the dividends were reinvested into mutual funds. In this instance, the assets are taken from the long run bucket when market prices are on the decline, which is ideally when you would want to jump at the opportunity to reinvest.
The bucket strategy only works if the buckets are being perpetually maintained. If the strategy covered above is the one used, some situations may affect retirees more than they think. For example, imagine that you're going through a year where stocks are not performing well. If that's the case, then you would "save" yourself by leaving bucket three alone. Instead, you would slowly drain the first two buckets to support yourself.
You would need to accept that you are effectively resigning yourself to wait until markets start performing reasonably again, and you are likely assuming that is going to happen in a reasonable time.
However, there's never really been a measure of how much a retiree should allow the market to fall before deciding not to interfere with the final bucket. On the flip side, there is seemingly no measure to define when market recovery is satisfactory enough to start withdrawing from the third bucket again.
Additionally, if you assume that the market hasn't recovered for an extended period in one of these hypothetical situations, should there be a threshold that you allow the first buckets to decline to before deciding to withdraw from bucket three regardless of market recovery? Walking this balance calls the confidence behind the strategy into question.
How Well Can One Implement the Bucket Strategy in Practice?
There is also the matter of how well a retiree can implement the strategy, as this is not going to be the same across the board. However, this may not be such a huge concern as one can hire a financial advisor in Pittsburgh who can navigate their clients through this challenge.
Potential Bucket Strategy Alternatives
Systematic Withdrawal Strategies
Instead of defined and separate buckets for different needs, systematic withdrawal is a principle that sees investment in an appealing spectrum of different asset categories. However, they are all weighted similarly, which is the essential difference. A proportionate amount is then withdrawn monthly.
A financial advisor could be an asset here, as such a diverse portfolio requires regular rebalancing to accommodate the said withdrawals. This strategy only focuses on a single allocation target, and annual withdrawals become predictable.
The 45% Rule Theory
Here's another well-known retirement alternative to the bucket strategy. This time, 45% of your pretax, pre-retirement income each year should be generated by your retirement savings. The plan is for the rest of your needs to be handled by social security benefits.
Therefore, on average, a retiree must replace anywhere between 55% and 80% of pretax, pre-retirement income if an existing lifestyle is to be maintained.
Consult with One of the Expert Financial Advisors at The Kelley Financial Group
If you're interested in the bucket strategy and how you can implement it like others who have invested this way, then retaining the services of a certified financial planner can help.
The Kelley Financial Group is a well-regarded firm with a demonstrated track record to partner with in Pittsburgh, PA. The process of developing your action plan can be condensed into a simple four-step process, which is as follows:
Schedule a meeting with a top-tier financial advisor either over the phone or in person, which consists of understanding your investment objectives and desired strategies.
Using relevant factors such as your assets, net worth, and how you wish to spend your time and money, your goals are evaluated and set up.
The feasibility of reaching your goals is evaluated and hypothetical situations can be used to account for external factors that may have implications for your plan.
With an actionable plan in hand, it becomes time to pursue financial independence.
Here are your key takeaways. The bucket strategy is one that many people have used in retirement to help them manage their funds and expenses, as well as have contingencies in place for the future. It may seem like a lot to take in, but a certified professional at The Kelley Financial Group can work with you to create a solid plan whether this or another strategy is best for you.
If you have concerns such as understanding the difference between excess liability insurance and umbrella policy or learning what is AMT depreciation all about, they can help out.
*This material was prepared for The Kelley Financial Group.
*The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which strategies or investments may be suitable for you, consult the appropriate qualified professional prior to making a decision.
*There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
*Asset allocation does not ensure a profit or protect against a loss.