The Bucket Strategy: How to Organize Your Finances for a Stress-Free Retirement

As a financial professional with years of experience planning for clients’ next stage of life, I have witnessed the many questions people struggle with when they prepare to retire. “What happens if I run out of money in retirement?” and “How can I rely on the market with my entire retirement savings?” are some of the common questions asked. The bucket strategy helps answer these questions. By implementing the bucket strategy before retirement, you’ll be able to alleviate a lot of common stress factors.

Understanding the Bucket Approach

The bucket strategy is a way to organize your retirement savings into different “buckets” (in other words, accounts). Using the bucket approach correctly could help you manage risk and taxes and build a structured portfolio based on your risk tolerance and time horizon. There are three main buckets that you will need to focus on.

• First Bucket (The “Now” Bucket): This bucket consists of funds you expect to need in the first five years of retirement. This bucket can include something as simple as a high-yield savings account or your original savings account that you use for everyday expenses. Funds would ideally be invested in short-term bonds, money market funds, or a ladder of CDs. Money market funds would be a great option now, with current yields of ~5%. However, this rate is subject to change when interest rates drop.
• Second Bucket (The “Soon” Bucket): This bucket serves as a happy medium between the “now” bucket and the “later” bucket. Use this bucket for the money you need in the next six to 15 years in retirement. You will see this bucket invested in some stocks and fixed income. By mixing both, you should be at a moderate risk level.
• Third Bucket (The “Later” Bucket): The last bucket will consist of your money to use later in retirement. Since you have a longer time horizon with this bucket, you can afford to invest more aggressively. This bucket should consist of growth stocks and other alternative assets.

Having these three buckets of money will help ease your way into retirement. Knowing that you have immediate cash available for the upcoming years can alleviate the stress of taking your money out of the market, especially in a down market.

This strategy can offer great flexibility with your cash and money in the market. In a high market year, you can replenish your cash or invest excess cash in your long-term buckets. In a down market, you can use the cash that you have on hand when needed.

Managing risk is very important when saving for retirement, and this strategy can be a great way to do so. Investing your portfolio using the bucket strategy helps with inflation protection. This strategy is simple and effective, which, to some people, is better than complex investment strategies.

Establishing Your Buckets

When creating your buckets, you will need to calculate and forecast a few things. First, determine your yearly living expenses and an appropriate emergency fund amount. Next, determine how much money you think you will spend in the next five or so years. Make sure to factor in inflation costs and any large expenses needed. Then analyze your current retirement savings and investments. This will be to create the first bucket. As stated, invest this money in short-term investments.

Use the same strategy going forward with your next bucket for the next six to 15 years in retirement. Then invest this bucket into the appropriate stock and fixed income.

The last bucket will consist of your long-term funds for the next eight years and above. This will be invested in long-term equity funds with a small amount of fixed income if necessary, depending on your time horizon and risk tolerance.

When setting up your buckets, there are several key considerations to keep in mind. First, ensure that you adequately fund your “now” bucket. Underfunding this bucket is a common mistake and can force you to prematurely draw from the “soon” bucket. This may lead to unintended capital gains or losses and the risk of selling assets that weren’t intended for immediate use.

Additionally, don’t neglect your “later” bucket. Insufficient investment in this bucket can restrict your long-term growth potential. Regularly rebalance your investments to maintain the right asset allocation and address any imbalances.

It’s also crucial to know the tax implications of selling securities. Plan for different tax brackets before and during retirement to minimize taxes on securities sales and capital gains. By considering these factors, you can better manage your retirement finances and avoid common pitfalls.

While this may seem like a simple strategy, connecting with an advisor can be very helpful. There are many different things to take into consideration when doing this. An advisor can help you manage these complex situations to make the most appropriate retirement analysis.

The opinion of the author is subject to change without notice and must be considered in conjunction with relevant regulation, as well as subsequent changes in the marketplace. Any information from outside resources has been deemed to be reliable but has not necessarily been verified. Each individual has unique circumstances to which this information may or may not be relevant. Under no circumstances will this information constitute an offer to buy or sell and it does not indicate strategy suitability for any particular investor.