What’s in Your Buckets?

The so-called “bucket strategy” is one of several approaches for drawing money from an investment portfolio in retirement. It is promoted as especially helpful for managing “sequence of returns risk,” which is the possibility that a bear market could hit right around your retirement date. If that were to happen, it could significantly decrease how much you could take from your portfolio without threatening your portfolio’s longevity.

Here’s the general idea. After determining your living expenses and how much income you will have from other sources, you then see how much money you will need to take from your investment portfolio each year. For example, if your living expenses are $80,000 per year and $60,000 is covered by Social Security and other sources (perhaps a defined-benefit pension and some part-time work), you need $20,000 per year from your investment portfolio.

You then put $40,000 to $60,000 of your portfolio in a money market fund or similarly safe, liquid investment. This is your cash bucket. All the rest is invested for growth. Some recommend three buckets, with bucket number two still invested somewhat conservatively and bucket three invested more aggressively.

In a bear market, you draw what you need from the cash bucket, thereby avoiding taking money from investments that are in decline. You continue doing so until those investments have recovered. When the money in buckets two and three perform well, you draw what you need from them while also topping off the cash bucket.

This all sounds well and good, especially for investors on the more conservative side of the risk tolerance spectrum. However, lots of questions begin to emerge when you look at this approach more closely and try to execute the strategy. And that’s where you come in. If you currently use some form of the bucket strategy, how would you answer the following questions? Or, if you’re not yet retired but are planning to use the bucket strategy, how would you answer?

When to fill the cash bucket

Do you begin filling the cash bucket several years before your planned retirement date or do you wait until you retire? Filling the cash bucket before retirement would seem to be the safer route, but if the market is doing well in the lead-up to retirement, that would lower your portfolio’s returns.

Where to keep the money in your cash bucket

How much risk are you willing to take with this bucket? If peace of mind is the main goal, you would probably want zero risk, leading you to a money market mutual fund or high-yield savings account. These days, you may be able to get 4%, but what about when the risk-free rate is much lower? Would you consider using a short-term bond fund? Something else?

How to manage the buckets

This is where the rubber really meets the road. There are lots of options here, with much depending on the performance of buckets two and three, and also how long a bear market drags on. Again, since peace of mind is the main goal, being guided by trustworthy rules would seem to be very beneficial.

Some suggest a rebalancing approach. For example, if the portfolio starts out at 50/40/10 (50% equities, 40% bonds, 10% cash), when the equities bucket moves above 50%, that’s where you draw funds for living expenses and perhaps to top off the cash bucket. However, even that sounds fairly vague. And do you do this rebalancing monthly? Quarterly? Annually? Do you then run a new analysis each year, perhaps using the Vanguard Nest Egg Calculator, to keep assessing your portfolio’s longevity? Is it worth the effort?

For those who already use the bucket strategy, does this approach end up truly giving you peace of mind, or does it add undue complexity and uncertainty?

In the near future, we plan to write a more detailed article about the bucket strategy, showing some specific options for executing the strategy, along with the pros and cons. Your input via responding to the questions in this article will be invaluable. So, bucket strategy enthusiasts, how have you managed the strategy? Or how do you plan to? Image used with permission.