The goal in retirement is to have an investment strategy that creates a steady stream of income while minimizing downside risk. Yet, the strategy needs to be aggressive enough in which your account can grow and keep up with inflation. There are many investment management philosophies but the the investment strategy I prefer is a bucket approach. The bucket investment strategy will help you grow your assets and allow you to feel comfortable with a withdrawal strategy in any market condition.
The Retirement Bucket Strategy
The bucket strategy is the creation of three investment strategies, a.ka. buckets, that work together to thrive in any market condition. The safety bucket is a very conservative investment strategy that doesn’t lose value even in the worse stock market conditions. The income bucket is a bucket filled with bonds and conservative dividend paying stocks that consistently refills the income bucket. The final bucket, the growth bucket, is a more aggressive strategy that shouldn’t be needed for at least 10 years. We’ll talk about the creation and maintenance of these buckets below.
The Safety Bucket
The safety bucket is the cornerstone of the bucket retirement income strategy. The safety bucket is simply two years of your known distributions sitting in a cash like account. This is where your distributions come from and allows you to handle the volatility of the stock market. For example, if you need to withdraw $40,000 per year from your retirement accounts, we would create a safety bucket with $80,000. The benefit of the safety bucket is that when financial catastrophe happens, you will have a steady account that won’t be affected by a falling stock market. The safety bucket is constantly being replenished by the dividends and income that are generated by the income bucket.
The Income Bucket
The income bucket is the next bucket that is created. The income bucket is heavy in income and dividend producing investments, such as bonds and dividend stocks. Although the main goal of this strategy is to produce income and consistently refill the safety bucket, it also is meant to grow and keep up with inflation. The income bucket typically is a balanced mix between stocks and bonds and because of the conservative nature, distributions can also occur from this account during economic downturns. Typically, the income bucket is created with enough assets to cover the next 10 years of your life.
The Growth Bucket
The growth bucket is a longer term account which is invested in a more aggressive nature. The principle of the growth bucket is meant to not be touched for a long period, unless strong stock market growth causes gains to be taken from this account. Although dividends and income from the growth bucket refill the safety bucket, it is more focused on long-term growth and is created to help meet income needs more than 10 years down the road. Typically the growth bucket is mainly filled with more aggressive equities and will contain a small amount of fixed income.
Creating Your Bucket Strategy
The creation of the buckets are the first step and although there are basic guidelines to each bucket, the overall strategy needs to meet your needs. For example, there are people that take more money out early in retirement because Social Security has not kicked in and expenses may be a little bit higher. In this case, you may overfill the growth and safety bucket and have less in the income bucket. This is because a majority of your income need will come in the first few years of retirement and later in life. Also, every person has different risk tolerances and this needs to be taken into account when creating the buckets. Although, the growth bucket is meant to be on the more aggressive side, some retirees may not feel comfortable with seeing too much risk in an individual account.
Example: $1 million portfolio with a $40,000 per year income need example
Maintaining Your Retirement Bucket Strategy
The initial creation of the buckets are very important but the maintenance of the bucket is vital for your successful retirement. For example, if the market is experiencing a downturn, you may not want to touch any of the buckets besides just taking distributions from the safety bucket. The other buckets will eventually recover and will benefit greatly by not drawing down assets when the market is down. During a more ‘normal’ market year, stocks and bonds may be liquidated from the income bucket to help refill the safety bucket. Finally, when the market is moving higher and the growth bucket is taking off, we move some of the risky assets in the growth bucket to both the income and safety bucket. This allows us to rebalance the portfolio while consistently making sure that there are funds readily available in the safety bucket.
A Low Cost ETF Investment Strategy
When you look at the overall investment strategy, the bucket strategy will closely resemble 60% stocks and 40% bonds/cash. I use low cost index ETFs that are strategically rebalanced on a quarterly basis. There is nothing sexy about this investment philosophy. It is a very disciplined approach that when done consistently, allows you to buy low and sell high. This isn’t the time to try to beat the stock market by making ‘bets’ on the hot stock or sector. If you want to keep some ‘mad money’ on the side in order to play the stock market that is fine, but this shouldn’t be your underlying investment philosophy. If you feel like the only way that you can live a comfortable retirement is by making large gains in the stock market, you should probably not retire yet.
Conclusion
The biggest problem that I see as an advisor is buying when the market is high and selling when the market is low. Nothing can ruin a retirement plan faster than ‘panic selling’, which is selling after the stock market experiences a selloff and sitting in cash when the market rebounds. The bucket strategy helps solve this problem. First, the strategic quarterly rebalance assures that you are constantly adding to areas which are currently lower, and taking gains from the high flyers. Second, the distributions that you are taking are always coming from a cash like account which never loses value, no matter what the market is doing. The diversified portfolio helps smooth out the lows and highs which should help you keep your wits about you, even when the market is hitting the skids. Last, the growth bucket allows you to take on a little more risk and long-term reward for the assets that you won’t touch for many years.
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