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As we turn the pages of our life story, one of the most significant chapters we all anticipate is retirement. It's a time to slow down and hopefully, enjoy the rewards of years of hard work.
However, ensuring a comfortable and stress-free retirement that will see you through to the end of your journey requires a strategic approach.
One popular and effective approach to consider is the bucket strategy. In this blog post, I'll explore what the bucket strategy is, how it works and why it can be a game-changer when it comes to managing your investment portfolio in retirement.
Understanding the Bucket Strategy for Your Retirement Portfolio
The bucket strategy, which is illustrated below, is a simple concept designed to provide retirees with a systematic way to manage their investments. The strategy involves dividing your portfolio into different "buckets," each serving a specific purpose and time horizon. Typically, these buckets are categorized based on the level of risk and liquidity associated with the investments. Each bucket is used to systematically "fill" the next bucket.
It allows you to categorize which assets you plan to liquidate over various periods of time instead of using one particular asset allocation plan for all of your investment assets. The idea is to allow for potential portfolio growth through more aggressive assets in your long-term bucket, without putting that same level of risk on the buckets you're earmarking to cover your near-term expenses.
To create the first bucket, you should account for two to three years of living expenses that won't be covered by income sources like Social Security, a pension or rental income, along with extra cash for an emergency fund in case you encounter a surprise expense. You should make sure to factor in inflation and any one-time big events, such as paying for a child's wedding or taking a big trip.
1. Short-Term Bucket (Cash and Cash Equivalents)
Purpose: Covering Immediate Expenses
Allocation: 1-2 years' worth of living expenses
Investments: Cash (high-yield savings and CDs), money market funds, U.S. Treasuries and short-term bonds.
Benefits: Provides a safety net for short-term needs, reducing the reliance on selling long-term investments during market downturns.
2. Medium-Term Bucket (Bonds and Conservative Investments)
Purpose: Meeting Mid-Term Goals
Allocation: 3-10 years' worth of living expenses
Investments: Investment-grade bonds and bond funds, U.S. preferred dividend-paying stocks and conservative mutual funds.
Benefits: Offers stability and a potential for modest growth, acting as a buffer against market volatility.
3. Long-Term Bucket (Stocks and Growth Investments)
Purpose: Long-Term Growth, Inflation Protection and Legacy
Allocation: 10+ years' worth of living expenses
Investments: High-yield bonds, diversified U.S. and international stock portfolio, equity mutual funds and alternative investments.
Benefits: Aims to outpace inflation over the long term, providing growth potential for sustaining a retirement lifestyle.
4. Legacy Bucket (Private Funds and Growth Investments)
Purpose: Leave Something Behind for Your Heirs
Allocation: 16+ years
Investments: Private market funds, growth-focused stock portfolio and mutual funds
Benefits: Aims to grow your wealth beyond your retirement needs to leave something behind for children, grandchildren and other heirs.
The Importance of Timing Risk in Your Retirement Portfolio
When building your bucket strategy, it's important to know about something called the "sequence of returns risk." This is a situation that involves the order and timing of poor investment returns in relation to when and how much you are withdrawing from your savings.
The risk occurs if your portfolio takes a major hit in the first few years of your retirement. If you take money out of your portfolio for living expenses at a time when it's losing value, you're forced to sell a larger percentage of your investments to raise the amount of cash you need to live on. Not only will you deplete your retirement funds faster than you planned, it leaves you with fewer assets to generate growth through the power of compound interest during future market recoveries.
Having your first bucket of short-term, low-risk liquid holdings of cash equivalents and cash can allow you to cover your expenses without tapping into your investment portfolio.
How to Implement the Bucket Strategy for Your Retirement Portfolio
1. Initial Setup
Assess your retirement goals, expected expenses and risk tolerance.
Determine the proportion of your portfolio to allocate to each bucket based on your yearly income needs, retirement timeline and financial objectives.
2. Regular Review and Rebalancing:
Periodically reassess your yearly income needs and financial situation and adjust the allocations in each bucket accordingly.
Rebalance the portfolio by moving gains from the long-term bucket to the short and medium-term buckets to maintain the desired allocation.
3. Market Conditions and Adjustments:
Be flexible in adjusting your strategy based on market conditions, interest rates and changes in your financial situation.
Replenish the short-term bucket during market upswings and consider reallocating assets during market downturns.
Benefits of Using a Bucket Strategy for Your Retirement Portfolio
1. Better Manage Risk
Minimizes the impact of market volatility on short-term expenses by ensuring a stable cash reserve.
Allows for long-term investments to recover from market downturns without the need to sell during unfavorable conditions.
2. Reduce Stress During Market Downturns
Knowing that your immediate and short-term needs are covered can help you avoid making a rash decision about your investments during times of market volatility.
Reduces the emotional stress associated with financial uncertainties.
3. Provide a Hedge Against Inflation
The long-term bucket aims to outpace inflation, which can increase your purchasing power over the duration of your retirement.
Maintain Consistency Using the Bucket Strategy for Your Retirement Portfolio
The bucket strategy offers a practical and systematic approach to managing your retirement portfolio, providing a balance between stability and growth. By carefully allocating your assets based on your time horizon and financial goals, you can enhance your financial resilience and enjoy a more fulfilling retirement.
Remember, individual circumstances vary, so it's essential to consult with a financial advisor to tailor a bucket strategy to your unique needs and preferences.
Disclosures
This post is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes.
Investing involves risks including possible loss of principal. Past performance is no guarantee of future results.