Retirement investing with the bucket system

While I'm primarily an index fund investor — and at 48 years old still have 80% of my money in equities (my only bonds are “legacy” bonds) — I do like to read about other approaches to retirement investing. I've long been tempted by the Permanent Portfolio, for example.

The November 2017 issue of Kiplinger's features suggested portfolios for five stages of life. Mostly I disagree with them, and I don't like that the funds they promote are expensive. That said, I think their approach to retirement investing is interesting. On the surface, it's the age-old “60% stocks/40% bonds portfolio”. What makes it interesting, however, is their reasoning behind this asset allocation.

The Bucket System

Kiplinger's suggests that retirees can balance both risks using what they call a “bucket system”. Here's how it works.

  • Divide your portfolio into three “buckets”. Each one serves a specific purpose.
  • The first bucket contains one year's worth of living expenses. This money is in cash (or a cash equivalent). So, for instance, if you spend about $36,000 per year, then your first bucket might have $36,000 in a high-yield savings account.
  • Your second bucket contains enough money to cover expenses for nine years. For someone who spends $36,000 per year, this would be roughly $324,000. Kiplinger's says this money should be invested in “high-quality bonds or a fixed annuity”. In reality, it should be in something smarter than cash but safer than stocks — whatever that means to you.
  • The final bucket contains the rest of your retirement savings, which turns out to be 60% of the entire portfolio. You want to invest this money in “stocks and other aggressive options”. (For me, this would include real estate.) Your aim is for this bucket to be continually growing.

Naturally, you keep your buckets at the suggested levels through regular rebalancing. From the article:

Replenish your buckets periodically by trimming top performers in your third bucket and by selling bond-fund shares as necessary to refill the cash bucket. If the market tanks, hold off on touching your stock funds until they recover, even if doing so means you draw down your second bucket for a few years to pay for living expenses.

Like I said, this is a traditional 60/40 asset allocation, but it's explained in a manner that actually makes sense to me. It's still too conservative for me, but I could see why other folks might choose this option.

Finding Balance

Although Kiplinger's is pitching the bucket system as something for retirees, it's an idea anybody could use. Depending on your age, goals, and circumstances, your buckets might be different sizes and contain different assets.

Also, Kiplinger's notes that there's a balance to be had.

  • If your retirement portfolio is heavily invested in stocks (as mine is), then you must understand that you're taking on risk. If the market crashes, your portfolio value is going to plummet. People like me need to be okay with that. (I am.)
  • On the other hand, if you're too cautious and move too much from stocks to bonds (or cash or gold), you'll miss out on gains. Your portfolio might not even keep up with inflation!

As always, investing is a balancing act. You pursue higher returns while also hedging against potential problems. There's no one right answer. You have to do what works for you and your situation.

[Kiplinger: Best Investing Moves for Retirees]
More about...Investing, Retirement

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shobir
shobir
2 years ago

Interesting…
I have a similar approach where I divide my portfolio into 3 parts which include bonds, stock, and cash,

I will be looking at this strategy now.

Thanks for sharing the idea.

Joe
Joe
2 years ago

This sounds pretty reasonable. I could adapt this to fit our style.
– 9 years of expense seems like way too much to me. I’d probably go with 5 at the most.
– The rest, I would still be flexible with. Not all in equity. If the market is high like right now, then I’d allocate some into bond and other conservative investments.

It really depends on where you are in life.

aivanther
aivanther
2 years ago

I’ve read some of their arguments. It doesn’t seem bad, especially if you’re more risk averse than I am. In my mind, though, what it really comes down to is “60/40 with a larger than normal daily operating account”.

lmoot
lmoot
2 years ago

I don’t know how transferable this info would be for a younger person though. Wouldn’t maxing out retirement accounts come before bonds? Usually those within the first decade of their careers can’t afford to max out ROTH (if eligible), HSA, 401K, maintain 1 year fund AND balance save in bonds at the same time. Maybe I read incorrectly, but it seems like the advice says if you have $20k to invest, you should only invest $12,000 in retirement/investments, and the rest in bonds/savings. I would think retirement would be more heavy-handed when younger.

Chris
Chris
2 years ago

I get the first and third bucket but what is the purpose of the second bucket? Why can’t that money be thrown in with the third?

Steven Horton
Steven Horton
2 years ago
Reply to  Chris

Totally agree Chris. This second bucket seems excessive, and I see no reason why this cannot be combined with the third bucket…?

Ron Cameron
Ron Cameron
2 years ago
Reply to  Chris

Well, no second bucket means no bonds/fixed income in this plan. Just cash and stocks.

Some Guy
Some Guy
2 years ago
Reply to  Chris

The second bucket is for periods when the market is down. If another recession hits and it takes the stock market a few years to recover, you spend money from that bucket and leave the money in the third bucket where it is, ready to grow back when the market starts going up again. For most people a market crash goes from bad to disastrous because they panic near the bottom and sell, then sit out until much of the rebound has passed them by before they get back into stocks again. While 9 years sounds excessive, I guess it… Read more »

Jason
Jason
2 years ago

I like this approach, but would probably tailor the 9-year bucket down to 7 years, just because 9 years feels overly conservative.

Damn Millennial
Damn Millennial
2 years ago

Thanks for the post.

I think the size of your portfolio would determine how much would be necessary for the “9 year bucket”. If you have a substantial portfolio I would not want that large of a position in bonds. I think laddering C.D.s for about 3 years of expenses if I was in “full retirement” would be plenty for me to sleep at night. My worry would be on not having my assets grow!

Thanks,

Damn Millennial

Fritz @ The Retirement Manifesto
Fritz @ The Retirement Manifesto
2 years ago

J.D., I’m a fan of the bucket system (even did an inforgraphic on it), and agree it’s a good way to drive asset allocation. I’m 219 days from retirement, and focusing on getting the buckets aligned with my targets before I pull the plug. Nice to see you back on GRS! Got shirts? (Wink).

Christian Chiakulas
Christian Chiakulas
2 years ago

I actually kind of like this idea, but for retirement some of that second bucket should be kept in a Health Savings Account. If you start early enough it’s a fantastic way to cover healthcare costs during retirement. This article says you might need as much as $400k just for healthcare costs in retirement, that’s mind-boggling to me. https://www.huffingtonpost.com/entry/how-health-savings-accounts-hsa-can-help-fix-american_us_59ef474ae4b08bce72fe03a9 I’m 26 and getting kicked off my dad’s health insurance next year. Since I’m young and can probably handle a high-deductible insurance plan, I’ll definitely be getting an HSA (and using it to invest!) next year.

Steve Juetten, CFP®
Steve Juetten, CFP®
2 years ago

You might be interested to know that the bucket system was introduced by Paul Grangaard, a Minneapolis CPA and financial adviser in his 2002 book. The pros and cons of this strategy have been hotly debated since then and has been refined since then. The basic idea of the bucket strategy is based on time segments — that is, investments are held for different time segments when the investor needs it. Money that is needed soonest has the lowest volatility risk and money that is needed later has a higher risk/return characteristic. The two biggest advantages of a bucket system… Read more »

Don
Don
2 years ago

From my perspective the worst case scenario is the crash of 1929 as a reference point. According to the NY Times article I linked to, the total recovery time from the day of the crash was seven and a half years. We are old school and keep a high percentage of our money in whole life insurance policies (this vehicle survived the great depression while the banks failed), following the guidelines of R Nelson Nash. This vehicle would serve as our second bucket At the policies current state of funding we could go for four years without touching the index… Read more »

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