The ‘Bucket Strategy’ Every Retiree Should Know
Building a nest egg of investments is a key part of preparing for a comfortable retirement. But it’s also important to have some money on the sidelines to cover living expenses without requiring you to sell stocks. Doing so makes it easier to ride the ups and downs of the stock market while covering your essentials.
A popular guide to having both is the “bucket strategy.” Read on for details on what this strategy entails and how to implement it.
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How the bucket strategy works
The bucket strategy typically involves having three categories: short-term, mid-term and long-term assets. Cash is a short-term asset, since it’s something you will spend on everyday needs such as groceries and gas. Bonds can be used as mid-term assets that provide fixed interest payments. The bonds in a bucket strategy typically mature in three to five years.
Stocks make up the long-term assets in your bucket strategy and provide growth potential. Ideally, you won’t have to touch money you invest in the stock market for at least five years.
Bucket one: Your income safety net
An income safety net covers living expenses so that you don’t need to immediately touch your nest egg. Every year that you can delay withdrawing money from your portfolio is another year you give your money time to compound.
Financial advisors typically recommend an emergency fund with enough money on hand to cover at least six months of living expenses. If you’re closer to retirement, you may want to bump that fund up to cover a year or two — or even more — of living expenses.
You can put this money into a high-yield savings account so it collects interest, giving your short-term savings more mileage than it would receive in a traditional savings account.
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Buckets two and three: Stability meets growth
The second bucket consists of lower-risk investments than the third bucket, such as bonds and dividend stocks.
The third bucket is generally made up of stocks for long-term growth. Stocks tend to outperform bonds and can help keep inflation from eating away at your savings. It’s easier to stay invested in stocks if you have the other two buckets for the shorter-term, since you ideally won’t be forced to sell stocks during a correction to cover your living expenses. Keep in mind that this is just a general guide, and these buckets should be made up of assets that make sense for your specific financial situation and goals.
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Keeping it balanced
The value of each bucket will change throughout the year as you spend money and prices of assets increase or decrease. That’s why it's important to review your three buckets regularly — like once a year — to ensure that they are all alligned with your goals.
Start by calculating how much you spend each year to determine how much money you need in your first bucket. Knowing this number can help you figure out if you need to sell any stocks or if your income-generating assets are sufficient. If you have to sell stocks, starting with overweight positions can further diversify your portfolio and minimize your overall downside if one of your stocks loses value next year.
It’s also important to consider your risk tolerance and your specific financial position. Diversifying into lower-risk stocks may make sense for one retiree, while building out cash reserves could be the best move for another.
You will also have to consider how Social Security and interest alleviate your living expenses as you rebalance your buckets. Some investors may opt to only keep enough cash to cover a year’s worth of expenses so more of their money can grow in the stock portfolio, while others may want to have more cash on hand.