The Bucket Approach to Financial Planning

The bucket strategy reduces the likelihood that a retiree will need to sell investments when they decline in value, but it cannot eliminate this risk completely.

Bucket one contains low-risk, liquid assets like certificates of deposit, US Treasury bills and money market accounts. This bucket replenishes itself from interest and dividend income.

Long-Term Bucket

For this boom & bucket, the planner calculates a client’s annual spending needs and subtracts non-portfolio income sources such as pensions, social security benefits, etc. This gives the planner a solid projection of the client’s spending in future years.

Using the Bucket Strategy, we then create three separate portfolios:

Bucket one is filled with short-term, low-risk liquid assets to protect against longevity risk and provide liquidity. Bucket two contains high-quality income-oriented assets. And bucket three houses long-term, growth-oriented investments.

The advisor then rebalances these portfolios in line with their target allocations. This is done even in years when the stock market is down, so that the advisor avoids selling stocks and buying bonds at a discount.

Medium-Term Bucket

The medium-term bucket contains assets that may be volatile in the short term, but should provide inflation-beating returns over the longer term. These assets could include a mix of bonds and income-focused equities. They might also include an allocation to international investments.

This bucket should be invested in a diversified portfolio of stocks and related assets, with allocations to both domestic and global markets. A good strategy might use low-cost index funds for this purpose, as well as a small allocation to exchange-traded funds.

Bucket three includes a mix of domestic and international stock funds that might be expected to grow over the long haul, but not as quickly as the growth bucket. This bucket might also include an allocation to fixed-income assets, such as deferred fixed annuities.

Having a contingency plan for market downturns is essential for long-term retirement planning. Market downturns that occur toward the end of your working life or early in retirement can have a significant impact on your ability to maintain a comfortable lifestyle throughout your lifetime.

Short-Term Bucket

For many retirees, especially those with a long life expectancy, bucket strategies can be an effective way to manage withdrawals and reduce the risk of selling assets during down markets. However, implementation is not without challenges, and it can also add complexity and cost to the overall strategy.

For example, the first bucket could contain a year’s worth of expenses in low-risk liquid investments such as high-yield savings accounts, ladders of short-term certificates of deposit and money market funds. While this bucket would earn some interest, it is not intended to generate much in the way of returns.

The second bucket might include a more conservative mix of bonds and income-focused equities. This bucket will be used for withdrawals in the next three to five years, and is expected to grow slowly enough to keep pace with inflation. The final bucket is typically invested in higher-risk, growth-oriented assets that will not be accessed for 7-15 years or more.

Cash Bucket

A bucket strategy requires careful planning to ensure that you are able to maintain the balances within each time period. This can be difficult for individuals who may be tempted to shift to cash out of fear during market downturns, but with financial education and proper guidance from an experienced professional, the strategy can be effective.

The short-term bucket can be filled with low-risk liquid assets, such as savings accounts, certificates of deposit, money market accounts and even a few very short-term treasury bills. The goal is to have enough ready funds to cover your expenses in the next two years, insulating you from market losses and giving the long-term and medium-term buckets time to potentially generate growth again.

The money that you will need in the medium to long term can be held in income-producing assets, such as high-quality bonds and dividend-paying stocks. In addition, deferred fixed annuities can provide a highly efficient source of guaranteed income for the mid to long-term, particularly if a “income for life” rider is included.