Your Retirement Portfolio in Three Buckets

by: Michael Snowdon, CFP®, CRPC®

After entering retirement, people often become concerned whether enough money will be available to cover current cash flow requirements. The investing term for this is liquidity and it’s a significant concern. This is especially true when retirees are advised to focus on long-term investments so they don’t run out of money over an extended lifetime (i.e., longevity). There are several potential solutions to this dilemma. One such solution can be called the bucket portfolio. Here’s how it works and how it might solve concerns about having enough liquidity.

Divide your retirement portfolio into three parts buckets. The first bucket is used to fund day-to-day living expenses. The third bucket is used to fund longevity. The middle bucket is the go-between or transfer place to refill bucket number #1 as it is depleted. Let’s look more closely at the three buckets.

The first bucket holds income-producing assets. These could include CDs, money market funds, US Treasuries, pension, fixed annuity and Social Security funds – things that will not decrease in value and are readily accessible when needed. You won’t earn much money in this bucket but that’s not its purpose. It’s to provide money to live. By placing an amount that will cover about two years of expenses in this bucket you won’t have to be concerned if the economy or investment markets take a dip. No worries, you’ll be covered.

What about longevity? That’s where bucket #3 comes in. Bucket #3 can hold stocks, high-yield bonds, real estate and other higher return assets. These are long-term investments targeted to help keep you from running out of money as the years pass. Consider this bucket as holding assets you won’t need for at least seven, up to 25-35 years.

Bucket #2 should hold from two to seven years’ funding. In this bucket you will need to factor inflation along with some level of conservative investment return. Investments in the middle bucket should be limited to investment-grade bonds (intermediate term), senior and junior notes, preferred stock, high-grade blue-chip (dividend-paying) stocks and perhaps high-quality real estate investment trusts (REITs). These are options that generally produce income and dividends, are considered reasonably conservative and fairly liquid/marketable.

As you spend money from Bucket #1 each year, assets can be liquidated from Bucket #2 and moved to refill Bucket #1. A corresponding amount can be moved from Bucket #3 to Bucket #2. Assets in the second and third buckets will continue growing to help you address the danger of running out of funds. This assumes that you have built a cushion or safety net for emergencies, extra medical expenses and other financial surprises. It also assumes you have accumulated a large enough retirement cash flow portfolio, and you maintain reasonable spending habits.

Increased longevity provides more opportunity for retirees to run out of money. The solution to providing adequate cash flow and protecting against running out of money is either to accumulate very large sums or to keep as large a portion of accumulated assets as possible invested, while gradually liquidating amounts needed to provide current cash flow. The longer-term investments can help offset purchasing power problems related to increased longevity. The three bucket system presented here is one solution to consider how well it might work. If you find this interesting you may want to arrange an appointment with a trusted advisor to discuss how it might apply to you.

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