The bucket strategy is a popular retirement income approach that divides your portfolio into separate time-based segments or buckets. Each bucket has a different investment objective and time horizon, providing both psychological comfort and practical protection against market volatility. By keeping several years of expenses in safe, liquid investments, you can avoid selling stocks during market downturns – a key defense against sequence of returns risk. This guide provides a detailed roadmap for implementing the bucket strategy in your retirement.
In This Article
1Understanding the Three-Bucket Framework
The classic bucket strategy uses three buckets. Bucket 1 (short-term) holds 1-2 years of living expenses in cash, money market funds, or short-term CDs. This provides immediate liquidity and peace of mind. Bucket 2 (medium-term) holds 3-7 years of expenses in bonds, bond funds, and conservative investments. This provides stability and modest growth while replenishing Bucket 1. Bucket 3 (long-term) holds the remainder in stocks and growth investments. This provides the growth needed to sustain your portfolio over a long retirement and eventually replenish Buckets 1 and 2.
2Sizing Your Buckets Appropriately
Proper bucket sizing depends on your total portfolio, annual expenses, and risk tolerance. A common approach: if you need $60,000 annually from your portfolio and have $1.5 million saved, Bucket 1 might hold $120,000 (2 years), Bucket 2 might hold $300,000 (5 years), and Bucket 3 holds the remaining $1,080,000. More conservative investors might increase Buckets 1 and 2; more aggressive investors might reduce them. Consider your other income sources – if Social Security covers half your expenses, your buckets only need to cover the remaining half.
3Investment Selection for Each Bucket
Each bucket requires different investments matching its time horizon. Bucket 1 investments should be completely safe and liquid: high-yield savings accounts, money market funds, short-term Treasury bills, or CDs. Bucket 2 investments balance safety with modest returns: intermediate-term bond funds, Treasury bonds, investment-grade corporate bonds, or conservative balanced funds. Bucket 3 investments focus on growth: diversified stock index funds, dividend growth stocks, REITs, and international equities. Avoid overlap – each bucket should have distinct investments serving its specific purpose.
4Refilling Buckets: The Replenishment Strategy
The key to bucket strategy success is systematic replenishment. Spend from Bucket 1 for daily expenses. When Bucket 1 runs low (typically annually), refill it from Bucket 2. When Bucket 2 needs replenishment, transfer from Bucket 3 – but only during favorable market conditions. If stocks are down significantly, delay Bucket 3 transfers and let Bucket 2 continue funding Bucket 1. This flexibility is the bucket strategys primary advantage: you never have to sell stocks at depressed prices because you have years of expenses in safer investments.
5Psychological Benefits and Practical Considerations
Beyond financial protection, the bucket strategy provides significant psychological benefits. Knowing you have years of expenses in safe investments helps you stay calm during market volatility. You can watch stock prices fall without panic because you are not dependent on selling stocks for immediate income. However, the strategy requires discipline and monitoring. You must resist the temptation to move money between buckets based on market predictions. Some critics argue the strategy is essentially the same as a traditional balanced portfolio with systematic withdrawals – but the mental accounting benefits are real and valuable for many retirees.
Key Takeaways
- Divide portfolio into short-term (1-2 years), medium-term (3-7 years), and long-term buckets
- Keep immediate expenses in safe, liquid investments
- Refill buckets systematically, avoiding stock sales during downturns
- Size buckets based on expenses, portfolio size, and risk tolerance
- The strategy provides both financial protection and psychological comfort
Conclusion
The bucket strategy offers a structured, intuitive approach to retirement income that protects against sequence risk while providing psychological comfort during market volatility. Success requires proper bucket sizing, appropriate investment selection, and disciplined replenishment. While not the only valid retirement income approach, the bucket strategy works well for retirees who want clear structure and protection against the temptation to sell stocks during downturns. Consider whether this approach aligns with your personality and retirement goals.