The Retiree 3 Buckets Approach to Asset Allocation

The Retiree 3 Buckets Approach to Asset Allocation

One of the most frequent questions we answer for pending retirees is “Where do I take my money from to supplement my other cash flow?” Our usual response is “Bucket 1”.

The Bucket approach to retirement income organization was pioneered by financial planner Harold Evensky in the 1970s when interest rates and inflation were very high. The risk of having to sell when the market was down scared a lot of future and current retirees. Having 2-3 years of future withdrawals stashed in non-volatile bank or savings accounts gave them peace of mind so they didn’t have to worry in the short term about the stock market.

Broken down into three phases, called buckets, this system allows retirees to visualize the timeframe and risk associated with each bucket. It helps to avoid what is called “sequence risk”, a term that denotes having to sell in a down market to generate income from a stock market portfolio. Bucket 1 involves no volatility and is limited to bank checking, bank certificates of deposit, insured savings accounts and money market funds in investment accounts.

Bucket 2 includes securities that are mostly fixed income but affords retirees more income along with some degree of volatility, but much less than stocks or equities. They are held for 3-7 years, for example. The investor/retiree receives more income but has to deal with share prices that might go down if interest rates go up. For example, a loss of 5% might be expected at some point in time.  Before the money is needed, the investor can sell the security and put the proceeds into Bucket 1 to refill a dwindling supply of money for withdrawal.

Lastly, Bucket 3 is devoted to a longer-term time horizon such as 7 or more years. Equities and more volatile fixed income (like junk bonds) usually produce good long term returns but are risky if they have to be sold for use in a shorter time period. The goal for the investor is not to sell these investments in shorter time periods as a loss might be experienced. Selling some of the increased value securities in this bucket and placing the proceeds in either Bucket 1 or Bucket 2 will help refill these buckets as they are withdrawn for income needed by the investor.

So how much should you have in Bucket 1 if you’re a soon to be retiree? How about three years of funds needed plus your emergency fund? That’s it. You can sleep at night and not worry about the stock market.  Entering retirement should be fun. With your buckets allocated properly, you’ll be set for that wonderful first time period we like to call the “go-go phase”.

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Jim Ludwick
Jim Ludwick

Jim Ludwick is the founder of MainStreet Financial Planning. His varied education and life experiences have enabled him to apply his knowledge and experience into useful solutions for personal financial problems. His writing and broadcasting activities allow him to help many more than just individual clients. He loves a microphone.

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