How to Use a Bucket Strategy to Manage Your Retirement Portfolio

How to Use a Bucket Strategy to Manage Your Retirement Portfolio

As you approach your golden years, managing your retirement portfolio becomes increasingly crucial. For those of you in your 40s and 50s, now is the perfect time to start thinking about how you’ll structure your investments to provide a steady income stream throughout retirement. One popular approach that has gained traction in recent years is the bucket strategy. This method can help you balance the need for current income with long-term growth, potentially providing peace of mind during market volatility.

What is the Bucket Strategy?

The bucket strategy is an investment approach that divides your retirement savings into three distinct “buckets,” each designed to cover different time horizons and financial needs .2 .4. By segmenting your assets this way, you can better manage risk and ensure a steady income stream throughout retirement.

The Three Buckets

1. Short-Term Bucket (Years 0-5): This bucket is designed to cover your immediate expenses in the first few years of retirement. It typically contains low-risk, highly liquid assets.

2. Intermediate Bucket (Years 6-10): This bucket aims to provide income for the medium term while allowing for some growth. It usually consists of a mix of fixed-income investments and some stocks.

3. Long-Term Bucket (Years 11+): This bucket is focused on growth and is typically invested more aggressively in stocks and other higher-risk, higher-reward assets.

Benefits of the Bucket Strategy

The bucket strategy offers several advantages that make it appealing for middle-aged individuals planning for retirement:

1. Peace of Mind: By having your short-term expenses covered in a low-risk bucket, you can worry less about market fluctuations affecting your immediate income needs .3.

2. Flexibility: The strategy allows for customization based on your individual retirement goals and risk tolerance .9.

3. Behavioral Benefits: The bucket approach can help control emotions during stock market volatility, as you know your immediate needs are covered .9.

4. Balanced Approach: It provides a framework for balancing the need for current income with long-term growth potential .2.

Implementing the Bucket Strategy

To effectively implement the bucket strategy, follow these steps:

1. Estimate Your Retirement Expenses

Start by tracking your current expenses using apps like Everydollar or Mint .12. Use this as a baseline to estimate your retirement expenses, factoring in potential changes like healthcare costs or travel plans.

2. Calculate Your Income Needs

Determine how much income you’ll need annually in retirement. Don’t forget to account for inflation, which can erode your purchasing power over time.

3. Fund Your Buckets

Once you have a clear picture of your income needs, it’s time to allocate your assets to each bucket. Here’s a general guideline:

• Short-Term Bucket: Aim to have 2-3 years of expenses in cash or cash equivalents .9.

• Intermediate Bucket: Allocate enough to cover 4-7 years of expenses .4.

• Long-Term Bucket: The remainder of your portfolio goes here, focusing on growth .4.

4. Choose Appropriate Investments

Each bucket should be invested according to its time horizon and purpose:

• Short-Term Bucket: Cash, high-yield savings accounts, money market funds, short-term bonds .9.

• Intermediate Bucket: A mix of bonds, dividend-paying stocks, and some growth-oriented investments .4.

• Long-Term Bucket: Primarily stocks, including both domestic and international, small-cap to large-cap .9.

5. Regularly Review and Rebalance

The bucket strategy isn’t a “set it and forget it” approach. Regularly review your buckets and rebalance as needed. This might involve selling some assets from your long-term bucket to replenish your short-term bucket .7.

Example Bucket Strategy

Let’s consider an example for a 55-year-old with $1 million in retirement savings, planning to retire at 65:

• Short-Term Bucket (Years 0-5): $250,000 in cash and short-term bonds

• Intermediate Bucket (Years 6-10): $300,000 in a mix of bonds and dividend-paying stocks

• Long-Term Bucket (Years 11+): $450,000 in a diversified stock portfolio .12

Potential Pitfalls to Watch Out For

While the bucket strategy can be effective, it’s important to be aware of potential drawbacks:

1. Overexposure to Fixed Income: Be cautious not to allocate too much to your short and intermediate buckets, as this could limit long-term growth potential .6.

2. Rebalancing Challenges: Failing to rebalance regularly or doing so at inopportune times can jeopardize the strategy’s effectiveness .7.

3. Complexity: Managing multiple buckets can be more complex than a traditional total-return approach .4.

Alternatives to Consider

The bucket strategy isn’t the only approach to retirement income planning. Other strategies to consider include:

1. The 4% Rule: This simple approach suggests withdrawing 4% of your portfolio value each year, regardless of market performance .12.

2. Systematic Withdrawal: This method involves dividing your total portfolio value by your estimated years in retirement and withdrawing that amount annually .12.

3. Total Return Approach: This strategy focuses on overall portfolio growth rather than separating assets into buckets .4.

Tailoring the Strategy to Your Needs

Remember, the bucket strategy is flexible and can be adapted to your specific situation. Consider factors such as:

• Your risk tolerance

• Your desired lifestyle in retirement

• Your health and life expectancy

• Your estate planning goals

For example, if you have a pension or other guaranteed income sources, you might allocate less to your short-term bucket. Conversely, if you’re planning extensive travel early in retirement, you might need a larger short-term bucket.

The Role of Professional Advice

While the bucket strategy can be implemented on your own, working with a fee-only fiduciary financial advisor can be beneficial, especially when it comes to:

• Accurately estimating retirement expenses

• Selecting appropriate investments for each bucket

• Developing a rebalancing strategy

• Navigating tax implications of withdrawals

An advisor can also help you determine if the bucket strategy is the best approach for your unique circumstances .