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.
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]