Running out of money in retirement ranks as one of the biggest worries of investors. In a 2017 BlackRock Investor Pulse Survey, 55 percent of Americans said outliving their savings was a top concern. Just 36 percent were confident they’d have enough income in retirement.
Although investing early and often can help counter those fears, how and where you allocate your assets are just as important as how much you invest. That’s where the bucket strategy comes in. This strategy uses a three-pronged approach to generate income before and during retirement. Assets are allocated to one of three buckets, based on when you’ll need to begin liquidating them.
The goal is to create a consistent income stream that you can draw on pre-retirement and throughout the rest of your life. “The bucket plan is a way to holistically structure your savings to tackle today’s market challenges while meeting your immediate, short- and long-term goals,” says Jason L. Smith, president and CEO of Westlake, Ohio-based Clarity 2 Prosperity and author of “The Bucket Plan: Protecting and Growing Your Assets for a Worry-Free Retirement.”
[See: The Best ETFs Retirees Can Buy.]
Smith says investors should have “now,” “soon” and “later” buckets. The now bucket is designed to cover living expenses and larger emergency expenses in the first year or two of retirement. This is typically money in the bank, Smith says, although you don’t want to overfill this bucket because “returns will be minimal and likely won’t keep pace with inflation.”
The soon bucket holds money that you may need to access sooner rather than later. Typically, this bucket covers years three through 10 of retirement. Smith says assets in this bucket should be invested for conservative growth, giving you higher returns than the now bucket without exposing you to extreme movements in the market.
The later bucket is for the final phase of retirement. This bucket is designed for long-term growth and legacy planning. Having the first two buckets in place gives investors “confidence to invest in higher-growth opportunities and longer-term commitments through the later bucket,” Smith says. For married couples, the later bucket should also account for changing income and tax needs when one spouse passes away.
The bucket strategy can insulate your retirement portfolio from sequence risk and longevity risk. The former refers to the risk of earning lower or negative returns early on when withdrawing retirement assets. The latter simply means outliving your savings. Although it can simplify your retirement plan, the bucket strategy isn’t foolproof. There are pros and cons to consider before divvying up your investments.
Pro #1: There’s more predictability and peace of mind. Self-doubt has a way of tripping up investors saving for retirement, potentially resulting in bad decisions and hurting their returns over the long run. The bucket strategy can bolster both your retirement income and your confidence by providing more predictability and peace of mind, says Jeremy Shipp, managing partner of O’Dell, Winkfield, Roseman and Shipp in Richmond, Virginia. It also provides greater clarity of the overall retirement picture, because investors can see at a glance which bucket is creating income for each segment of their life.
By giving you more choice and flexibility about where to draw income from, a bucket approach can eliminate some of the uncertainty associated with shaping a retirement plan. Mark Lloyd, owner and founder of The Lloyd Group in Suwanee, Georgia, says that’s especially important when interest rates are rising.
[Read: How to Play Income Investments When Rates are Rising.]
As rates rise, more stress is placed on bonds and fixed income. “When investors know they have a protected income bucket with guaranteed income coming in that they can’t outlive, they’re less likely to be worried about market performance,” Lloyd says.
Pro #2: You can tap assets and still generate portfolio growth. Without a defined plan in place for drawing down assets in retirement, you could liquidate them at the wrong moment in the market cycle. With a bucket strategy, you can tap lower-yield investments like bonds while leaving stocks alone. Consequently, you can stay invested in stocks long term and avoid the temptation of reacting to short-term gains or losses in those holdings, says Joe Heider, president of Cleveland-based Cirrus Wealth Management.
In addition, having liquid assets in a savings or money market account to cover the initial years of retirement could enable you to delay dipping into retirement accounts, Smith says. The longer you sustain yourself with the funds in bucket one, the longer you defer paying taxes on withdrawals from a 401(k), traditional individual retirement account or a taxable brokerage account. At the same time, these accounts can continue growing in value.
Con #1: Estimates for retirement expenses must be accurate. Of course, no investment allocation can guarantee that you’ll hit your retirement goal, says Sean Pearson, an advisor with Ameriprise Financial in Conshohocken, Pennsylvania.
For example, one of the biggest pitfalls to impede the bucket strategy’s success is underestimating your expenses in retirement. “Spending too much or failing to consider the impact of health changes later in life can be more likely to derail your retirement than your allocation or strategy,” Pearson says. Estimating your retirement expenses accurately matters because “the bucket strategy typically works best when investors are taking sustainable withdrawal rates,”
Con #2: You need to be disciplined about generating a set return. Another potential flaw is that the bucket strategy speaks primarily to allocation, not performance. Mary M. Evans, senior client advisor at Boston-based TFC Financial Management, says investors must pay attention to whether their buckets are structured to provide the necessary rate of return to reach their retirement goals. For example, a more risk-averse investor may be tempted to hold on to larger amounts of cash. That may be a problem because “the drag of the cash bucket may dampen the overall return and create portfolio sustainability issues.”
[See: 9 Dividend ETFs for Reliable Retirement Income.]
Regular rebalancing can help downplay risk. If you’re going to use the bucket strategy for retirement, you can’t adopt a set-it-and-forget-it attitude. “Without carefully managing the portfolio, an investor could find themselves with too risky a portfolio later in retirement if they’ve allowed their ‘safe’ buckets to be depleted,” Evans says.
More from U.S. News
5 ETFs Yielding More Than 5 Percent
8 Boring Stocks With Soaring Potential
6 Strategies to Avoid Working in Retirement
The Pros and Cons of a Bucket Savings Strategy originally appeared on usnews.com
