Bucket-Based Retirement Planning
Have you ever asked yourself the question, "Will I outlive my retirement funds?" Many people saving for retirement will calculate how much money they need for an estimated duration, such as a 30-year retirement.
Concerns such as the complexities of taxes, healthcare, and unexpected expenses can also bring uncertainties into a retirement plan. Furthermore, potential inflation increases can chip away at your nest egg.
With so many moving parts in a retirement plan, how can anyone be confident they will have enough in retirement, let alone leave an inheritance?
One possible portfolio design approach is the bucket strategy, or bucket-based retirement planning.
What is the Bucket Approach?
Put simply, a bucket approach groups your assets into different categories, or "buckets", that address investments over time. The approach is used as a financial planning and asset allocation framework to allow a financial advisor, with their client, to customize retirement investments according to the client's overall goals.
For investing, the bucket approach creates a strategy for immediate concerns like short-term expenses and liquidity, then couples this stability with long-term investing practices to produce returns. Nobel laureate James Tobin developed this strategy to simplify investments and merge two seemingly opposing goals: monthly spending and support for future expenses.
For example, one bucket may contain assets for daily and monthly expenses for three to five years out. The investor may use another bucket to categorize those assets that can sit and grow for the next 10 or more years. You can create any number of buckets to contain assets for any goal or strategy. However, it's more common to have just three or four buckets: immediate, short-term, medium-term, and long-term (more about this later).
To summarize, the bucket approach is a method that can help segment assets and plan for investment income in retirement.
In general, bucket segments are built based on the periods in which the dollars are expected to be used. At Vector, we strictly use a liability-driven approach for the shorter-term segments of portfolios. As we extend into the longer-term segments and based on client goals, we progressively combine a liability-driven approach with an asset-only approach.
The Four Bucket Approach
At, Vector, we manage portfolios using four bucket segments:
1. Assured Income bucket (0-3 years)
2. Preservation bucket (4-10 years)
3. Accumulation bucket (10-16 years)
4. Legacy bucket (16+ years)
The first bucket will often be cash or cash-like for your income needs over the next few years. For example, you could decide to have $50,000 in cash, easily accessible, that will cover one year of household income needs. Typically, for individuals in or near retirement, we suggest having two to three years of income needs in readily accessible cash to maintain income stability during market downturns.
Clients in retirement or the distribution phase will typically have part of their portfolio in all four buckets. For example, 10% in Assured Income, 25% in Preservation, 15% in Accumulation and 50% in Legacy. Meanwhile, clients in the accumulation phase – those less than 10 years from retirement – may have a 3-6 month cash buffer, along with Preservation, Accumulation, and Legacy. We typically don't begin adding materially to Assured Income until a client is within three years of their target retirement date range. As a client approaches retirement (a journey, not a destination), we will add that segment and plan for their monthly income stream in retirement. Depending on markets and spending levels, a client's assets will cascade through the models over time, according to their spending requirements and legacy goals.
Each bucket is filled with a combination of assets that account for risk, requirements, short-term needs, and long-term goals. It's an asset allocation plan that can help counter any of the complexities and concerns of retirement while easing anxieties that come with relying on income from investments.
Bucket Strategy vs. Systematic Withdrawal Plan
The bucket approach is not the only strategy used for withdrawing, saving, and investing during retirement. Another common approach is known as the Systematic Withdrawal Plan, or SWP. Like the bucket approach, it is a plan to withdraw an income from your portfolio for your monthly expenses. However, the similarity shared between a bucket strategy and SWP ends there.
Systematic Withdrawal plans will group all assets together regardless of risk tolerance and time horizon, then withdraw a flat amount from each asset for the payout. This approach loosely follows the 4% rule in retirement, which is a questioned rule of thumb that suggests a retiree should withdraw 4% of their savings each year for 33 years.
Systematic Withdrawal allows less flexibility and can be difficult to adjust when income requirements or risk tolerance changes. Furthermore, the approach may not accurately reflect each retiree's immediate and future needs. Rather, it's based on a generalization about retirees and their needs and goals. So, not only does a SWP treat all client assets alike, but it also treats all investors alike, giving little notice to the needs of the individual.
This differs from the bucket approach, where each bucket can be rebalanced to reflect the complexities of retirement and each client's individual needs and risk tolerance. Some complexities include, for example, income adjustments, inflation, health care expenses, emergencies, and taxes, among other considerations. Moreover, although the systematic withdrawal plan offers more predictability regarding a fixed withdrawal schedule, it does not account for anxiety over monthly expenses when markets experience a steep drop.
Systematic Withdrawal can fuel an aversion to risk, which can lead to panicked and emotional decisions. The bucket approach, on the other hand, can give you peace of mind and patience during a market downturn because you have two to three years of accessible cash flow for expenses. This buffer keeps you from being a forced seller
Which Financial Strategy is Right for You?
Retirement plans look different for each individual because of the differences in lifestyles, needs, goals, and risk tolerance. Regardless of your chosen strategy, discussing it with a financial advisor is important. You and your advisor should weigh all the pros and cons to determine which strategy is right for your individual needs and goals.
We believe a bucket-based approach to retirement planning can help you make decisions devoid of emotion and panic, especially when faced with stress from market downturns. Using the bucket-based retirement strategy can also help you secure your immediate lifestyle without needing to make life-changing decisions during volatile market fluctuations.
How Sojourn Helps
At Vector Wealth Management, we treat each client as an individual and determine a strategy based on those individual needs. Using our proprietary software, Sojourn, every client has a custom weighting to each of the four bucket models across their entire household. This helps each client reach their income objectives in retirement.
We rebalance portfolios throughout the year to achieve the right mix of growth and stability based on each plan's requirements. We also frequently revisit the goals and needs of our clients to ensure the strategy is working and providing peace of mind.
A lot of firms use the bucket methodology for planning discussions with clients. We plan based on buckets, invest using buckets, and also report clients' performance and holdings based on buckets. We have found that tying these three elements together has been an effective way to help make informed and more objective decisions, both in terms of planning and investing.
Contact Vector Wealth Management today to learn more.