Mastering Retirement Cashflow: Your Guide to the Bucket Strategy
Retirement is a season of life which requires significant change, not just in lifestyle, but also in financial habits. You’ve been saving diligently for decades, steadily building your nest egg. But as you now approach retirement, the goals completely change as you are no longer adding to your savings every month but figuring out how to efficiently spend your money while ensuring that it lasts as long as you do. This is where the retirement bucket strategy can come into play.
The bucket strategy is a way to divide your savings into separate time-horizons, each serving a specific purpose. The bucket strategy can help create a framework to shift the mindset from accumulation to distribution, balancing the need for short-term liquidity, long-term growth, and overall risk management.
In this article, we’ll discuss how the bucket strategy works, the types of investments that belong in each bucket, and advantages and challenges of using the bucket strategy.
Whether you’re nearing retirement or already there, this article will help you evaluate if the bucket strategy aligns with your financial goals.
What is the Retirement Bucket Strategy?
At its core, the bucket strategy divides your retirement savings into three distinct categories based on your time horizon:
Short-Term Bucket: Funds needed within the next 1-5 years.
Medium-Term Bucket: Funds needed within the next 3-10 years.
Long-Term Bucket: Funds set aside for use after 8+ years.
The overlap in these time horizons allows you to create a framework that is unique to your situation. You can structure your buckets so that your bucket strategy will address your personal cash flow needs, investment growth goals, and risk tolerance.
Bucket 1: The Short-Term Bucket
Purpose:
The short-term bucket is your safety net, designed to cover current expenses such as your living and lifestyle costs, healthcare, and any unexpected emergencies that might arise. Think of the short-term bucket as an emergency fund on steroids.
Investment Options:
The primary goals for this bucket are liquidity and capital preservation, ensuring that the money will be there when you need it. Investments in this bucket should include:
Cash or Cash Equivalents: These include savings accounts, money market funds, and Treasury bills.
Short-Term Bonds: These include high-quality government or corporate bonds with a short-duration and low expected volatility. (Learn more about the role of bonds in your portfolio.)
Short-Term Certificates of Deposit (CDs).
Why It Works:
The funds in this bucket need to be available with very short notice. These investments are readily available and have limited exposure to market volatility. This bucket provides security and peace of mind and reduces the risk of having to sell investments when the market takes a turn for the worse.
Bucket 2: The Medium-Term Bucket
Purpose:
The medium-term bucket bridges the gap between the immediate cash flow needs of the short-term bucket and the long-term growth goals of the long-term bucket. The expected time horizon for the investments in this bucket should be somewhere between 3-10 years, depending upon how you have structured your buckets.
Investment Options:
The goals of the investments in this bucket are moderate growth and managed risk. Some suitable investments for this bucket should include:
Balanced Funds: These are funds that include a mix of stocks and bonds which provide both stability and growth.
Dividend-Paying and Value Stocks: These stocks are typically less volatile than growth-oriented stocks.
Intermediate-Term Bonds: These bonds offer higher returns than short-term bonds, with a bit more risk. But they are typically safer than longer term bonds.
Why It Works:
By using both value-driven stocks and intermediate bonds, this bucket navigates the delicate balance between growth and stability, ensuring that the funds are available when needed while still generating returns.
Bucket 3: The Long-Term Bucket
Purpose:
Our final bucket classification within this strategy focuses on exposing the portfolio to growth and appreciation. This will help your portfolio combat inflation and allow your investments to grow throughout your retirement.
Investment Options:
This bucket will expose this segment of your portfolio to higher-risk and higher-return investments. These investments include:
Growth-Oriented Stocks or ETFs: This includes exposure to large-medium and small cap growth stocks/funds. It may also include international and emerging market investments.
Real Estate Investment Trusts (REITs): This includes exposure to real estate assets.
Alternative Investments: This could include alternative investments that offer exposure to other assets that are not necessarily correlated to the stock and bond market.
Why It Works:
Because this bucket has a long-term time horizon, the holder will be able to withstand the short-term machinations of the equity and bond markets. The primary goal is to have these growth assets in your portfolio, but to never have to sell them distressed to fund living expenses. This highlights the importance of each of these buckets and how they work together in the strategy.
How the Buckets Work Together
While each bucket serves a distinct purpose, they are interconnected and function like a waterfall:
Depletion and Replenishment: As the short-term bucket gets spent, it is replenished with proceeds from the medium-term bucket. Similarly, the long-term bucket replenishes the medium-term bucket as needed.
Periodic Adjustments: The buckets should be regularly rebalanced based on the underlying investment performance and short-term cash flow needs.
Example:
Let’s take a retired couple with $2 million in savings. Their projected annual cash flow shortfall is $50,000 after factoring in Social Security and other sources of income. Given this fact pattern, this couple may want to structure there buckets as follows:
Short-Term Bucket: $200,000 in cash and short-term bonds to cover four years of cashflow needs.
Medium-Term Bucket: $300,000 in balanced funds and dividend stocks for the next 10 years.
Long-Term Bucket: $1.5 million in growth-oriented investments for inflation protection and future needs.
They periodically replenish their short-term bucket from the medium-term bucket and adjust their strategy based on their actual spending and market conditions.
Advantages of the Bucket Strategy
Peace of Mind: Reduces stress by covering immediate needs, regardless of market conditions.
Customizable: Tailor the time horizons and investment mix to fit your goals and risk tolerance.
Systematic Withdrawals: This creates an unemotional framework for rebalancing, reducing the risk of panic-driven decisions.
Market Volatility Mitigation: Avoids selling distressed investments by maintaining a buffer in the short- and medium-term buckets.
Challenges of the Bucket Strategy
Inflation Risk: Short-term assets may not keep up with inflation, eroding purchasing power.
Complexity: Requires ongoing management, including projecting expenses, selecting investments, and periodic rebalancing.
Tax Considerations: Balancing withdrawals across taxable, tax-deferred, and tax-free accounts can be complex. For example, $1 million in a pre-tax 401(k) does not equate to $1 million in cash after taxes.
Market Timing: Selling assets to replenish buckets does introduce an element of market timing to this strategy. This can be particularly challenging during periods of extreme market volatility.
Is the Bucket Strategy Right for You?
The bucket strategy is well-suited for retirees who value structure and seek a balance between growth and safety. It can be particularly effective for those with other income streams like Social Security, pensions, rental income, or part-time work.
But like all strategies, it does have its challenges. It’s not a one-size-fits-all solution. This strategy can be adversely affected by things such as inflation risk, taxes, and market timing. Consider these carefully before deciding if a bucket strategy is right for you. Consult with a financial advisor to help you navigate this strategy’s complexities and create a structure that is right for you.
Final Thoughts
The bucket strategy offers a structured and flexible approach to managing your cash flow and investments in retirement. By segmenting your investments into different time horizons, you can gain some clarity and confidence which will help you create a successful retirement drawdown strategy.
If you’re considering the bucket strategy, take the time to evaluate your goals, risk tolerance, and cash flow needs. And remember, professional guidance can make a world of difference.
For more insights, check out our post on the 10 Questions to Ask a Financial Advisor Before Hiring One. It offers some important details to consider when making this very important decision.
Presented by Irvine based Financial Advisor JP Geisbauer,CPA, CFP®, of Centerpoint Financial Management.
About Our Presenter:
JP Geisbauer is a Certified Public Accountant, a Certified Financial Planner ®, and the founder of Centerpoint Financial Management, LLC, a financial planning, investment management, and income tax planning firm located in Irvine, CA. JP Geisbauer is dedicated to helping California-based business owners and executives transition into retirement. He has been quoted in many news outlets including Forbes, Newsweek, US News & World Report, MarketWatch, YahooFinance, CNN and NerdWallet.
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Disclaimer:
This article is for general information and educational purposes only. Nothing contained in this article constitutes individual financial, investment, tax, or legal advice. Before taking any action on any topic discussed in this article, consult with your own financial planner, investment advisor, tax professional, and/or attorney for advice on your specific situation.