Bucket Strategy: Balancing Retirement Income Now and in the Future

How does the “bucket strategy” manage short-term vs. long-term income needs?

The “bucket strategy” is a popular retirement income planning method specifically designed to manage the distinct challenges of meeting both your immediate and long-term income needs throughout retirement. It works by dividing your retirement savings into separate “buckets,” each with a different time horizon and investment objective. This structured approach aims to provide both a reliable income stream for your current expenses and growth potential to ensure your money lasts throughout your retirement years.

At its core, the bucket strategy acknowledges that retirees have different financial needs depending on when they will require the money. It typically involves three buckets, although variations exist. Let’s break down how these buckets work to address short-term and long-term income needs:

Bucket 1: The Short-Term, “Now” Bucket (1-3 Years)

This bucket is designed to cover your immediate living expenses for the next one to three years. Think of it as your “spending money” bucket. Because you’ll need to access these funds soon, the primary focus here is on safety and liquidity. Investments in this bucket are typically very conservative, such as cash, money market accounts, short-term certificates of deposit (CDs), or high-quality short-term bonds. The goal is to preserve capital and minimize the risk of losing money, even if it means lower returns. Having this bucket ensures that you have readily available funds to draw from for your monthly income without being forced to sell investments during market downturns. This provides significant peace of mind, knowing your near-term income is secure and not subject to market volatility.

Bucket 2: The Mid-Term, “Soon” Bucket (3-10 Years)

This bucket is intended to provide income for the years following the short-term bucket, typically covering years three to ten of retirement. Here, you can afford to take on slightly more risk in exchange for potentially higher returns. The investments in this bucket are still relatively conservative but can include a mix of assets like intermediate-term bonds, dividend-paying stocks, or balanced mutual funds. The aim is to generate some growth to keep pace with inflation and provide a buffer for when you need to replenish Bucket 1. This bucket acts as a bridge, providing a transition from the immediate income needs to the longer-term growth bucket. It offers a balance between safety and growth, allowing your money to work a bit harder than in Bucket 1, but still with a focus on stability.

Bucket 3: The Long-Term, “Later” Bucket (10+ Years)

This bucket is the growth engine of your retirement plan. It’s designed for money you won’t need to access for at least ten years or more. Because of this longer time horizon, you can invest more aggressively to seek higher returns and outpace inflation over the long run. This bucket typically holds a larger proportion of growth-oriented assets like stocks (both domestic and international), real estate, or other investments with higher growth potential. While these investments come with more volatility, the long-term time horizon allows you to ride out market fluctuations. The growth from this bucket is crucial for ensuring your money lasts throughout a potentially long retirement and for maintaining your purchasing power as living costs rise over time.

Managing the Buckets and Refilling:

The bucket strategy is not a static “set it and forget it” approach. A key element is the process of refilling the buckets. Typically, you would draw your income from Bucket 1. As Bucket 1 gets depleted, it is replenished by selling assets from Bucket 2. Bucket 2, in turn, is replenished by selling assets from Bucket 3. This “cascading” system ensures that you are always drawing income from the most conservative bucket first, and only tapping into the longer-term growth bucket when necessary to replenish the shorter-term buckets. Furthermore, periodic rebalancing is crucial. This involves selling assets from buckets that have performed well and reallocating those funds to buckets that may be underfunded or need replenishment, maintaining your desired asset allocation and risk levels across the buckets.

In summary, the bucket strategy effectively manages short-term versus long-term income needs by creating a tiered system of funds. It provides immediate income security through the conservative short-term bucket, while simultaneously ensuring long-term financial health through the growth-oriented long-term bucket. This structured approach can help retirees feel more confident and in control of their finances throughout their retirement years, knowing their income needs are addressed both now and in the future.