You’ve done it: you worked hard for decades, setting aside money in various accounts and investments in order to fund your retirement. You built up a strong portfolio, reduced your annual expenses, and now, it’s finally time to retire.
Chances are that you designed your retirement savings goals around a strategy like the 4% Rule… but what sort of rule should you follow when it comes to actually pulling those funds out to use in retirement? That’s where the bucket strategy comes into play.
Let’s talk a bit about what the bucket strategy is, what it does for retirees, and whether this is the rule you should follow in terms of your retirement spending.
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What is the Bucket Strategy
The simplest definition of the bucket strategy is that it’s a way to manage your investments in retirement.
Before retirement, you may think of your investments in terms of allocations. You put some money in stocks, some in bonds, leave some in cash, and perhaps the rest is tied up in assets like your home or rental property. All combined, these investments form your retirement savings.
This method works great for most: it spreads your efforts out, allowing you to take advantage of all sides of the market while also limiting your risk. But once you retire, and you actually need to start spending that money, it brings up one very important question: where do you take money from when you need it?
Your various retirement investments represent your “buckets of cash.” Each will continue to keep your money safe while supporting you in retirement and even growing your returns.
The bucket strategy dictates that your savings be categorized into different buckets according to how each investment operates. You are able to pull from one bucket throughout the year to support your expenses, refilling that bucket later on from the growing funds of another bucket.
Why the Bucket Strategy is Helpful
By putting retirement accounts into individual buckets, it helps many investors see where they should pull funds from and in what order.
Some of your buckets’ funds are less volatile than others, such as bonds and savings accounts. This money can be utilized relatively quickly and without much loss, and has a lesser impact on your taxes.
Other buckets, like the one that holds your stocks, are more aggressive. They have the potential to grow your money better and, as such, should be utilized first. These funds may also be difficult to access when you need cash for everyday expenses, or could result in a loss if money was pulled out at the wrong time.
By knowing which investments are contained in which bucket–and how much you can pull from each in a given year–it helps reduce loss and expenses while giving you access you the retirement funds you need.
Examples of the Bucket Strategy
Typically, you will find that there are two- and three-bucket approaches, but just like asset allocations, there is no one right bucket strategy. For the sake of our example here, we will use a three-bucket strategy that has a combined value of $1 million.
- Bucket one is our cash bucket. It contains two years’ worth of living expenses in checking, savings, and money market accounts.
- Bucket two is our bonds bucket. It includes our fixed income investments, as well as other investments that aren’t volatile but still earn interest. This bucket equates to about five years’ worth of expenses or so.
- Bucket three is our everything else bucket. It contains whatever is left, usually in stocks. Because the other two buckets contain about seven years of expenses, this bucket can afford to be a bit more volatile.
If bucket three takes a hit in an economic downturn, we can simply leave it alone. We would have two other buckets to pull from while bucket three recovers its value; in an ideal situation, we wouldn’t even feel the effects. After all, buckets one and two (with combined living expenses of nearly a decade) would historically give you enough of a buffer–between cash and bonds–to survive until bucket three rebounds.
This sounds great in theory but, of course, we can’t live on theory. Instead, there are three big concerns that are raised with this strategy, beginning with: when do we start refilling buckets?
Issue One: Refilling Your Buckets
If you pull from buckets one and two to cover living expenses, these buckets would eventually be depleted. Since they rely on cash stores, bonds, and other less volatile investments, it’s unlikely that their growth would keep up with your annual spending. So at some point, you’ll need to refill those.
Do you pull from the next-highest bucket to refill every year, like a waterfall? In doing so, you’re effectively just taking money out of stocks (and isn’t the point of the bucket strategy to avoid exactly that?). Or do you only refill when stocks are up and it makes sense to sell (and how much attention does this strategy require)?
Issue Two: Asset Allocation
If we think about the 4% rule, we realize just how much asset allocation matters.
Generally, if you’re between 50-75% in stocks at retirement, with the rest in bonds, the 4% rule will work. If you have more than 75% or less than 50% in stocks, your failure rate goes up. (No, your portfolio isn’t doomed, but the likelihood goes up.)
The bucket strategy doesn’t really take this into consideration.
Issue Three: Buying and Selling Stocks
When stocks (typically held in bucket three) are down, what should we be doing? Not only should we not be spending (by way of selling those stocks), but perhaps we should be taking money out of bonds and buying stocks.
Isn’t that the point of investing, after all? This gets our allocation back, reinvests our funds, and even rebalances our portfolio. But the bucket strategy doesn’t really take this into consideration either.
Solution: Kick the Bucket (Strategy)
If you’re a fan of the bucket strategy, you might not want to hear this. My belief, though, is that the answer to these three issues is to more or less kick the bucket strategy down the road entirely.
Simply return to a standard asset allocation strategy when it comes to managing your retirement investments.
Stick between 50-70% in stocks
Let’s say we have 60% of our portfolio in stocks with 40% in bonds. How do we tap that to spend money in retirement? Where do we pull from first?
The answer is that it doesn’t matter.
(Yes, it’ll matter as far as taxes are concerned, but we aren’t talking about that today.) If we rebalance our portfolio annually anyway, the outcome will be the same at the end of the year. It doesn’t really matter.
It’s still wise to pay attention to the market and how your stocks are behaving; selling low or buying high is never a good strategy. But that aside, it won’t make a big difference in the financial success of your retirement if you spend from stocks or spend from bonds.
Utilize Your Bond Allocation
It might be wise to include the cash you’ll need for the next year or two in your bond calculation (so of that 40% bond portion, some of it is actually being held in cash savings).
You don’t have to, of course; you could just pull funds monthly from a bond account. But keeping some cash in savings or checking may be easier and would still technically count toward your bond allocation, since the volatility is similar.
Spend the money you need throughout the year and then reevaluate at the end; depending on what the market has done, the interest you’ve earned, etc., you may even find that your stock allocation isn’t that far off, even though you’ve been exclusively spending from the bond side.
Rebalance a bit to get back to 60/40, if needed, and continue on your way.
Why I Like this Better
To summarize, I believe that the bucket strategy is an unnecessary complication.
The idea of worrying about multiple buckets–spending from one or two of them throughout the year or drawing from one to refill another–seems a bit convoluted. How do you decide how much to keep in each bucket, where do taxes come into play, when do you refill, and what is the right allocation for you?
Instead, it seems smarter to just worry about your basic portfolio composition. Split your savings into roughly 60% stocks and 40% bonds (plus cash); pull from the latter to cover your annual expenses, then rebalance at the end of the year.
This keeps you focused on your asset allocation first, which is really necessary in order for this whole retirement thing to work anyway. This is especially true if you’re following the 4% rule and want your money to outlast you.
As with any financial advice, this might not be the answer for everyone. For many, though, keeping things simple and straightforward might be the best way to ensure a successful retirement.