When it comes to your retirement, one of the biggest fears you may have is that you’ll run out of money before you run out of time — and it’s a common worry. According to a 2020 survey by Allianz Life, six in 10 non-retirees have this precise fear. You’ll almost certainly need to keep some of your money invested in stocks in your senior years to keep parts of your portfolio growing even as you live off of those investments. But if there’s a bear market during your retirement years, having to sell stocks or other assets while their values are down can heighten your risk.
However, not holding stocks at all comes with its own set of risks. If your portfolio’s growth can’t outpace inflation, you are much more likely to outlive your money. If you’re looking for a plan that will let you invest for growth while keeping the money you’ll need in the near term safe from volatility, the bucket strategy may be right for you.
How does it work?
To use the bucket strategy, you divide your retirement assets into three categories based on when you will draw down on them. The first bucket is for money that you intend to spend very soon — over the next year or two. This money should not be invested. Keep it in your bank accounts.
The next bucket is for the portion of your portfolio that you expect to use in the medium term — say, from two to 10 years in the future. You can invest this money but not in assets that are apt to fluctuate too much. This bucket should be made up of fixed-income investments like certificates of deposit and bonds.
The last bucket is for growth. Money that you don’t expect to use for at least 10 years can be invested in instruments like stocks that will provide you with higher long-term rates of return. Even if there’s a market crash during your retirement, you will be able to hold onto those stocks for quite some time, which should give your portfolio time to recover. As bucket one runs low, you’ll replenish it from bucket two, which in turn should be topped off by shifting money from bucket three.
Pros of a bucket strategy
Using a bucket strategy can help you control your emotions and prevent you from selling investments out of fear. Because the money that you’ll need over the next 10 years has no stock market exposure, your immediate livelihood won’t be threatened by short-term market fluctuations.
Deciding on a bucket strategy before you hit your senior years can also help you plot out a retirement income strategy. Many people make plans about how they will save for retirement throughout their careers, but they may not give as much thought to the spending-down phase of things. A bucket strategy requires you to map out how much you will spend each year in retirement ahead of time. Planning how you will use your money in advance may help you stick to your budget better.
Cons of a bucket strategy
Even if the growth bucket of your portfolio is invested entirely in stocks, your asset allocation model may be too conservative. Imagine, for example, that you have $500,000 saved for retirement and will have $25,000 in expenses annually beyond what your Social Security payments will provide.
Using this strategy, you’ll hold $50,000 for the first two years in cash in your bank accounts. In the second bucket, $200,000 will be invested in fixed-income assets. The remaining $250,000 will be invested into a growth portfolio made up mostly or entirely of stocks. Using this allocation, your overall portfolio will be at most 50% stocks. The amount of growth that those assets can provide may not be enough to adequately slow down your portfolio depletion over the course of a long retirement.
Your estimates of how much you’ll need in each bucket should be precise, but figuring a long-term budget out in advance can be hard. You may underestimate how much you’ll need in your first bucket and end up withdrawing funds from the other two before you planned on doing so. You also might over-allocate to your first and second buckets, and fail to put enough money into assets that can deliver long-term growth.
You save for retirement hoping that you will be able to build a nest egg sufficient to last your entire lifetime. But to give yourself the best chance of succeeding, you’ll also need to have a plan for how you will use what you’ve saved. Income distribution plans like the bucket strategy can help give you peace of mind and ease your fears that you won’t have enough.
View more information: https://www.fool.com/investing/2021/01/16/whats-a-bucket-strategy-your-retirement-portfolio/