Financial security is all about income. You can have millions in assets. But if you don’t have an income system that works, how are you going to pay your bills? Some retirees try to solve this problem by using a bucket strategy. Let’s take a look at what that is and if it really works or not.
What is a bucket strategy?
The answer to this depends on who you ask. The traditional approach looks something like this. Typically you’d have 3 buckets; cash, bonds or preferred shares, and equity. The cash bucket would have enough money to provide 2 years of income needs. Any money you need over the next 3 to 15 years would be put in bonds. Any funds left over would be invested in equity. According to this approach, you would put more into bonds and cash as you age.
Who this system works for.
This income approach is very systematic and straight forward. It’s also extremely conservative. As a result, there are a lot of people who might feel good about this approach. But despite these benefits, this is not the best way for most retirees to generate investment income in my experience. Here’s why:
1. Emotion vs Intellect
The older we get the more conservative we become. That is absolutely true. But just because we become more conservative it doesn’t necessarily mean our portfolios need to follow suit. This may seem very counter-intuitive but your investments shouldn’t really be governed by your age. They should be governed by when you need/want the money. Consider this example:
If you are 55 and plan on retiring in 10 years you still want your money to provide income for at least as long as you live. Sure you’ll start tapping into the account in 10 years but you’ll probably want to continue drawing from the well for another 30 years after that. That said you have to think about your retirement assets with a very long-term time frame.
This traditional bucket system would have you put your money in bonds just because you will start your withdrawals in 10 years. That’s could be a very costly mistake and it squanders the benefit of having a very long term investment period because this system does not recognize it.
2. Cash Needs & Bond Investments.
Why keep a two years’ worth of income sitting around doing nothing? That’s a lot of cabbage and to me it makes no sense.
And when it comes to bonds, the conflict is even greater. Right now, interest rates are very low. Does it make sense to lock up a ton of money for 15 years at these low rates? Not in my book it doesn’t.
3. Build A Better Bucket
The concept of using a bucket system is generally helpful but the traditional approach just doesn’t make a lot of sense today. By all means, set up a cash reserve account to satisfy your emergency needs and income needs for 6 months.
If there are purchases that need to be made over the next 5 to 7 years, I suggest using a very conservative equity income approach. And if you are OK with the risk, consider using at least some equity to grow the balance of your accounts. Then, use a systematic withdrawal to create the monthly income you want.
The bucket system is good in theory because it asks you to think about differentiating your assets and investing accordingly. But like everything when it comes to money, one size does not fit all.
Think about what your short, intermediate and long-term needs are. Invest money in each of those pools appropriately. But take into consideration the low rates available in the banks and the potential risks of bonds as well as the risk and volatility of the stock market. Identify the truly long-term money and consider using equity growth for at least a portion of that money. My experience tells me this can be a great way to provide liquidity,income and growth over your entire life.
Are you using a bucket system? How?