The Bucket Approach to Retirement Savings
The Bucket Approach to Retirement Savings
By: Stacey Nickens
When my children were young, we used to go apple picking every fall. Sometimes we would even drive all the way to rural Illinois to enjoy some fresh apples, homemade apple butter, and homemade apple pie. Of course, there are so many types of apples. It was always a challenge to make sure we didn’t end up with too many of one kind. If we picked too many Granny Smiths, we would be eating apple pie for weeks. If we took home too many Golden Delicious apples, apples would be our only snack for the next year.
As is the case with apples, retirement planning is all about balance. Such is especially true when part of your retirement income involves invested assets. Balance will help ensure your funds last you through retirement. Importantly for times such as these, balance will also help you remain calmer when the stock market becomes volatile.
The Bucket Strategy advocates for keeping a certain amount of money liquid for current living expenses. You then keep a certain amount of money invested with the goal of income production. Finally, you have a certain amount of money invested with the goal of growth. Balancing your assets across these buckets allows retirees to have cash on hand while still benefiting from dividend income and equity growth. The lesson may be to not put all of your apples in one bucket. The lesson may also be that focusing too much on one kind of apple may mean you miss out on benefits from other kinds of apples.
Bucket 1 will hold liquid cash in order to meet your short-term living expenses. To determine how much cash you need in Bucket 1, calculate your annual living expenses. Subtract any income you receive from Social Security, pensions, or other stable income sources. The number you calculate will determine the baseline amount of cash you should keep in Bucket 1. More conservative or risk averse investors may want to hold two times this amount in cash. More growth-oriented investors may want to put their Bucket 1 cash into a short-term bond fund or another holding with slightly higher yields.
Bucket 2 will include assets invested for income production. These assets should amount to at least five years’ worth of living expenses. Your investments in this bucket could include quality fixed-income positions, dividend-paying equities, and other income-generating securities. The income you generate in this bucket can then be used to replenish Bucket 1 as it is depleted each year or every couple of years.
Bucket 3 will include assets invested for growth over the long-term. These assets could include more stocks and growth-oriented investments. You will regularly rebalance this bucket to ensure it is meeting your long-term needs. You will work to rarely rely on Bucket 3 for short-term living expenses. You can thus leave the money invested during market drops and rest calmly knowing it has time to recover. In the meantime, you will be living off cash in Bucket 1 and income generated in Bucket 2.
The Bucket Strategy will require regular maintenance as Bucket 1 is depleted. When this happens, you could consider the following sequence to replenish Bucket 1. However, you should decide what sequence best meets you and your family’s needs.
- Replenish Bucket 1 with income generated in Bucket 2 (and possibly Bucket 3).
- Replenish Bucket 1 by rebalancing Bucket 2 and Bucket 3. For example, you could sell a stock that has seen significant gains in order to generate income.
- Replenish Bucket 1 by withdrawing from the principal in Bucket 2. (This strategy would likely be most effective if equities had taken a hit and selling those equities would involve taking a loss.)
Overall, the Bucket Strategy allows retired investors to both participate in stock market growth and protect some of their savings from stock market volatility. The strategy will need to be adapted to each individual’s unique needs. As you review your asset allocation, make sure your apples are spread across buckets and be strategic about what apples you use and when. Finally, after you’ve done all this financial planning work, reward yourself with some apple pie!
