The bucket approach to retirement planning gives you access to money for expenses but the upside potential to grow your investments
Retirees used to rely on what was called the three-legged stool idea for retirement planning. Most people could rely on money from social security, a pension fund and their own individual retirement savings as three key supports for holding them up in retirement.
With the collapse of the pension system and the inevitable demise of social security, it’s becoming increasingly likely that most people will be balancing on just one-leg of that stool.
To address the problem, financial advisors have come up with the bucket approach to retirement planning. The bucket system is a great way to separate and manage your retirement investments to provide safety for expenses while still enjoying the upside potential to grow your investments.
The Bucket Approach to Retirement Planning is not an Either/Or Decision
A retiree in the 80s could put their money in Treasury bonds or ultra-safe corporate bonds and glide through retirement on a stream of coupon payments. The rate on the 30-year Treasury Bond exceeded 14% in 1981 and corporate bond rates approached payouts of 20% or more. Inflation ate away at your payments but annual price increases came under control by the early 90s and bond prices kept rising on lower interest rates.
My how times have changed. The 30-year Treasury pays a yield of just 2.75% a year to lock your money up for three decades. Low rates on bonds have led to a dangerous either-or situation for investors planning their retirement.
You can keep your money in the safety of fixed-income, with rates on investment grade bonds providing about 2% return after inflation. At this rate, your retirement accounts amount to little more than a savings account and with healthcare costs rising faster than general inflation, it isn’t really an option for most retirees.
Many retirees have opted for the alternative, taking on more risk for a higher return. Investors have piled into junk bonds, dividend stocks and other risky investments to gamble on their retirement goals. Anyone planning their retirement during 2008 could tell you the problem with this strategy. Stocks in the S&P 500 lost 1% annually over the 10 years to 2010. That’s a decade of losing money in stocks.
It’s clear that this either-or approach isn’t going to work for retirement planning going forward, especially without the benefit of social security or the pension system to fall back on.
Enter the bucket approach to retirement planning.
The bucket approach calls for three distinct groups of investments through retirement. Your first bucket is for cash investments like very short-term bonds. These investments won’t provide much of a return but will provide for your current expenses.
In your second bucket of investments, you place 5- to 10-year bonds and income producing stocks. This bucket is designed to produce cash which will be used to refill your cash bucket, more on this later. You still want to invest in safe investments like investment-grade bonds and dividend stocks of very large companies.
Your final bucket is composed of stocks and high-yield bonds for capital appreciation potential. These investments may not produce much cash through dividends but the value of the bucket should grow over the years.
You’ll want to hold some precious metals exposure like gold and silver within both your cash bucket and the capital appreciation bucket. Gold and silver are highly liquid which will give you quick access to cash if you need it but they also hold strong long-term price potential, giving your third bucket the growth it needs. All of these investments can be held in an IRA or 401k investments.
How to Maintain a Bucket Approach Retirement
You’ll be spending out of your first ‘cash’ bucket each year but will need to refill it annually. Start with about 18 – 24 months of expenses in your cash bucket. Each year, you can move some of the cash produced from the second bucket to refill what you spent out of the first bucket.
Only using the cash produced from your second bucket to refill the cash bucket should mean that the value stays pretty consistent. Try keeping around three to five years of expenses in your second bucket. This will produce enough cash to refill the first bucket but also a safety net to cover a few years of weak stock prices.
During years when the stock market does well, you’ll also use the added value on your third bucket to refill the other two buckets. If stocks jump 10%+ in a year, you’ll be looking at a much higher value in your capital appreciation bucket. Put some of this money into your second bucket so you’re producing more cash each year. If you keep enough money in your first and second buckets to cover a few years of expenses, you won’t have to touch your third bucket when the stock market falls. You’ll be able to wait out the time until your third bucket refills itself through higher stock market gains.
This bucket approach to retirement planning provides the best of both worlds, safety in cash and bonds with the potential for higher returns on stocks. Managed correctly and you won’t have to worry about running out of money due to low rates or high-risk investments.
With the bucket approach, investors divide their retirement assets into separate buckets of assets based on periods of time. Those time horizons can be flexible as can be the number of buckets, but three is a common choice.
The buckets are divided based on when you'll need the money: short-term, medium-term, and long-term. The short-term bucket has easily accessible money, the medium-term bucket has money in things that generate income, and the long-term bucket has money in things that grow over time.
What is the retirement bucket strategy? The bucket approach to retirement income is based on separating assets according to when they are going to be spent, creating a cash cushion for the early years of retirement, while maximizing the rest over a longer period of time.
The 3 Bucket Strategy is a well-known financial planning method that categorizes assets into three separate 'buckets': short-term income needs, intermediate requirements and long-term necessities.
The central premise is that the retiree holds a cash bucket (Bucket 1) alongside his or her long-term assets, both stocks and bonds. If the long-term components of the portfolio, especially stocks, hit a rough patch, the cash bucket ensures that the retiree has enough liquid assets to use for living expenses.
The 4% rule limits annual withdrawals from your retirement accounts to 4% of the total balance in your first year of retirement. That means if you retire with $1 million saved, you'd take out $40,000. According to the rule, this amount is safe enough that you won't risk running out of money during a 30-year retirement.
The 4% rule is a popular retirement withdrawal strategy that suggests retirees can safely withdraw the amount equal to 4% of their savings during the year they retire and then adjust for inflation each subsequent year for 30 years.
Sure, a Roth IRA withdrawal will be tax-free, but you may wind up paying more in lost opportunity. Instead, withdraw from taxable retirement accounts first and leave Roth IRAs alone for as long as possible.
The 4% Rule is intended to make your retirement savings last for 30 years or more. This rate of withdrawals means that most of the money used will be the interest and gains on investments, not principal, assuming a reasonably healthy market return.
This is a procedure for washing, rinsing, and sanitizing where a different bucket and sponge or mop is used for each task. The 3 Buckets system always been seen in Cruise Passenger Ships to follow the Sanitation standards of Publich Health (PH).
Like the cup that runneth over, a full bucket gives us a positive outlook and renewed energy. Every drop in that bucket makes us stronger and more optimistic. But an empty bucket poisons our outlook, saps our energy, and undermines our will. That's why every time someone dips from our bucket, it hurts us.
The bucket strategy divides your retirement savings into three distinct buckets based on when you'll need the money: immediate, medium-term, and long-term. Here's how it works: Immediate Bucket: This bucket contains funds in liquid assets, readily available for any short-term needs or emergencies.
An example of the “bucketing” approach is a $750,000 portfolio in three parts, or “buckets”: Bucket 1 = $60,000; Bucket 2 = $240,000; Bucket 3 = $450,000. Total annual income needed from investments: $30,000. Bucket 1 portfolio is $60,000 in cash (and CDs, money market accounts, etc.)
If the interest rate on your debt is 6% or greater, you should generally pay down debt before investing additional dollars toward retirement. This guideline assumes that you've already put away some emergency savings, you've fully captured any employer match, and you've paid off any credit card debt.
The bucket strategy and systematic withdrawal strategy are similar in theory since asset allocations tend to be very similar between both options. That said, there's a very real difference between the two strategies in practice, thanks to the effects of local fallacies and investors' cognitive biases.
A good plan isn't just about the size of your nest egg. It's also about how you manage these three things: taxes, investment strategy and income planning.
Financial planners and other advisors sometimes divide retirement into three basic phases: an early, active phase when retirees may travel widely or embark on other adventures they had to put off during their career years, a more settled and somewhat less active phase, and a third phase in which the effects of aging ...
High-3: If you entered active or reserve military service after September 7, 1980, your retired pay base is the average of the highest 36 months of basic pay. If you served less than three years, your base will be the average monthly active duty basic pay during your period of service.
Hobby: LARPing, Kitesurfing, Sewing, Digital arts, Sand art, Gardening, Dance
Introduction: My name is Amb. Frankie Simonis, I am a hilarious, enchanting, energetic, cooperative, innocent, cute, joyous person who loves writing and wants to share my knowledge and understanding with you.
We notice you're using an ad blocker
Without advertising income, we can't keep making this site awesome for you.
