Four bucket strategy for investing

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Bucket Strategy vs. Systematic Withdrawal Plan The bucket approach is not the only strategy used for withdrawing, saving, and investing during retirement. Like the bucket approach, it is a plan to withdraw an income from your portfolio for your monthly expenses. However, the similarity shared between a bucket strategy and SWP ends there.

Systematic Withdrawal plans will group all assets together regardless of risk tolerance and time horizon, then withdraw a flat amount from each asset for the payout. Systematic Withdrawal allows less flexibility and can be difficult to adjust when income requirements or risk tolerance changes.

Furthermore, the approach may not accurately reflect each retiree's immediate and future needs. Rather, it's based on a generalization about retirees and their needs and goals. So, not only does a SWP treat all client assets alike, but it also treats all investors alike, giving little notice to the needs of the individual. This differs from the bucket approach, where each bucket can be rebalanced to reflect the complexities of retirement and each client's individual needs and risk tolerance.

Some complexities include, for example, income adjustments, inflation, health care expenses, emergencies, and taxes, among other considerations. Moreover, although the systematic withdrawal plan offers more predictability regarding a fixed withdrawal schedule, it does not account for anxiety over monthly expenses when markets experience a steep drop. Systematic Withdrawal can fuel an aversion to risk, which can lead to panicked and emotional decisions.

The bucket approach, on the other hand, can give you peace of mind and patience during a market downturn because you have two to three years of accessible cash flow for expenses. Retirement plans look different for each individual because of the differences in lifestyles, needs, goals, and risk tolerance. Regardless of your chosen strategy, discussing it with a financial advisor is important. You and your advisor should weigh all the pros and cons to determine which strategy is right for your individual needs and goals.

We believe a bucket-based approach to retirement planning can help you make decisions devoid of emotion and panic, especially when faced with stress from market downturns. Using the bucket-based retirement strategy can also help you secure your immediate lifestyle without needing to make life-changing decisions during volatile market fluctuations.

How Sojourn Helps At Vector Wealth Management, we treat each client as an individual and determine a strategy based on those individual needs. Using our proprietary software, Sojourn , every client has a custom weighting to each of the four bucket models across their entire household. This helps each client reach their income objectives in retirement. We rebalance portfolios throughout the year to achieve the right mix of growth and stability based on each plan's requirements.

We also frequently revisit the goals and needs of our clients to ensure the strategy is working and providing peace of mind. A lot of firms use the bucket methodology for planning discussions with clients. We plan based on buckets, invest using buckets, and also report clients' performance and holdings based on buckets. We have found that tying these three elements together has been an effective way to help make informed and more objective decisions, both in terms of planning and investing.

Contact Vector Wealth Management today to learn more.

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For example, it might be held in a Money Market Fund or a high yield bank account. Having too much cash can drag down portfolio performance. Money in the cash bucket should be separated from your primary checking account. Cash in a primary account tends to be too easy to spend.

Instead, retirees can set up automatic monthly transfers from the cash account to their checking account. This allows them to mimic the monthly paychecks they earned during their career. Conservative: The conservative bucket holds for four to six years from retirement. Usually, high-quality government bonds or CDs would be appropriate for this bucket.

A short-term or intermediate-term bond fund could work too. Given the low-yield environment, this bucket may just match inflation. It may even under-perform inflation slightly. However, in most cases, it will perform better than the cash bucket, and the assets should be fairly stable. Intermediate: In the intermediate bucket, retirees may want to take a bit more risk.

This could be the right bucket for a mix of high-quality bonds and perhaps some equities depending on your willingness to accept volatility. Growth: The goal of this bucket is to produce long-term growth for your investment portfolio. Most of this money should be invested in growth assets like stocks. The portion of your portfolio should ideally have both domestic and international exposure.

Stock mutual funds or low-cost index funds could both fit well in this bucket. Preferred stock or higher-risk bonds may also fit in this bucket depending on your investment preferences. It would not make sense to spend all your conservative assets during the early years of retirement. Instead, retirees will want to refill the cash bucket using assets from the other buckets. Refilling buckets does not require rigid rule following or careful attention to the financial markets.

Instead, a quick portfolio review a few times per year should be enough for a retiree to decide how to refill the buckets. The exact refilling strategy can depend on market performance from the previous year or two. To refill the cash bucket, retirees first want to look to income dividends or yield from all the buckets. When stocks do well, selling some of the stocks from the growth bucket is preferable. During a good year, the stock portfolio will continue to have a very high value, even after the retiree sells some shares.

Assuming both portfolios were the same size, Karen's portfolio would be a lot more aggressive. Of course, that also assumes that Karen is OK with the swings that will inevitably accompany her aggressive portfolio; that may or may not be the case.

Misconception 2: You spend from the buckets sequentially. Once you've segmented your portfolio by your anticipated spending horizon, you need to have a system for maintaining those allocations an ongoing basis. One common point of confusion on this front is that you'll "spend through" the buckets sequentially--that is, you'll spend your cash first, then move onto short- and intermediate-term bonds, while saving stocks for last. That makes a certain amount of sense, in that cash is the safest asset for very short time horizons, bonds have historically been quite safe assuming you have a time horizon of at least five years, and stocks have been pretty reliable for time horizons of 10 years or longer.

First, such a strategy would leave a retiree with an increasingly aggressive portfolio. True, research conducted by financial planning experts Michael Kitces and Wade Pfau suggested that an asset allocation that grows more aggressive with time can help retirees avoid "sequence of return risk"--encountering a bum market early in retirement.

But an increasingly aggressive portfolio might create behavioral challenges, as many older retirees prioritize being able to sleep easily over growing their nest eggs. Perhaps more important, spending down cash and bonds first has the potential to leave an investor with a very aggressive, stock-heavy portfolio at a time when it's not opportune to draw from it because stocks are depressed. For that reason, I like the idea of using income and rebalancing proceeds to help supply liquidity to the portfolio on an ongoing basis.

Rebalancing to a target allocation also serves to keep the portfolio from skewing to a single asset class over time, as depleting the buckets sequentially would tend to do. It also allows you to be opportunistic in terms of where you turn for cash flow in a given year.

Misconception 3: Income-centric retirees won't benefit from buckets. Another misconception is that buckets are only for total-return-oriented retirees, and the strategy won't work for more income-focused investors. It's true that I used a pure total return approach in my bucket stress tests , reinvesting dividends and capital gains back into the portfolio and refilling Bucket 1 with the proceeds from rebalancing appreciated positions.

But the Bucket strategy doesn't have to be interpreted so narrowly; I would urge investors to apply their own investment philosophies when implementing the bucket approach. For income-focused retirees, one possible strategy would be to have income from your bonds and dividend-paying stocks flow directly into the cash bucket. If, after a year of taking in dividend and bond payments, Bucket 1 is full, you're all set.

But if that amount isn't sufficient to meet your living expenses for the year ahead, you can sell securities. Such periodic selling might be desirable to restore your portfolio to its asset-allocation targets. The past three years provide a good example of a period when such rebalancing-related selling would be desirable: Bucketers may have found the income from their bonds and dividend-payers insufficient to meet their income needs, but strong equity performance could mean that trimming long-term holdings fulfills additional cash-flow needs.

Alternatively, there may be years in which income production from the portfolio is insufficient to meet living expenses and the market is also down--that is, there is no choice but to draw from Bucket 1. In such an instance, bucket 1 is there to serve as a buffer--to tide the investor through a style environment.

Misconception 4: A Bucket strategy can help address a savings shortfall. The Bucket approach is an easy-to-understand way to organize your portfolio based on your anticipated time horizon, but it's not a miracle worker.

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Usually, high-quality government bonds or CDs would be appropriate for this bucket. A short-term or intermediate-term bond fund could work too. Given the low-yield environment, this bucket may just match inflation. It may even under-perform inflation slightly.

However, in most cases, it will perform better than the cash bucket, and the assets should be fairly stable. Intermediate: In the intermediate bucket, retirees may want to take a bit more risk. This could be the right bucket for a mix of high-quality bonds and perhaps some equities depending on your willingness to accept volatility. Growth: The goal of this bucket is to produce long-term growth for your investment portfolio. Most of this money should be invested in growth assets like stocks.

The portion of your portfolio should ideally have both domestic and international exposure. Stock mutual funds or low-cost index funds could both fit well in this bucket. Preferred stock or higher-risk bonds may also fit in this bucket depending on your investment preferences. It would not make sense to spend all your conservative assets during the early years of retirement. Instead, retirees will want to refill the cash bucket using assets from the other buckets.

Refilling buckets does not require rigid rule following or careful attention to the financial markets. Instead, a quick portfolio review a few times per year should be enough for a retiree to decide how to refill the buckets. The exact refilling strategy can depend on market performance from the previous year or two.

To refill the cash bucket, retirees first want to look to income dividends or yield from all the buckets. When stocks do well, selling some of the stocks from the growth bucket is preferable. During a good year, the stock portfolio will continue to have a very high value, even after the retiree sells some shares.

In that case, retirees may want to sell some of the bond assets from the conservative or moderate buckets. When neither bonds nor stocks do well, retirees can hold off on rebalancing for a year or two. After all, the first bucket starts with enough cash to cover two or three years of spending.

Remember, every retirement investment strategy starts with your budget The bucket strategy is one useful framework for managing your investment portfolio during retirement. But this strategy, along with most other investing frameworks require you to know your budget. The Retirement Budget Calculator can help you understand your cash-flow needs in a detailed way.

It forces you to look in detail at your major budget categories , so you can successfully plan your total needs. Here are some of the key misconceptions I hear bandied about in relation to the Bucket approach. Misconception 1: Social Security and pensions should be part of your buckets. There are different ways to implement a Bucket approach. But I think the strategy is the most useful for organizing assets that you can invest and spend--that is, your investment portfolio.

But I think it makes the most sense to factor them in at the beginning of the retirement-planning exercise rather than into the buckets themselves. To do otherwise is to risk getting bogged down in abstractions that ultimately aren't that useful. Start the process by considering your total anticipated spending needs in retirement. After that, take a look at how much you'll have from certain, nonportfolio sources of income: Social Security, a pension, or a fixed annuity.

In this group I would put anything that offers a guaranteed source of lifetime income and is out of your control in terms of its management. The amount that's left over is the amount that your portfolio will need to replace annually. Armed with that figure--your annual portfolio spending--you can then segment your portfolio by time horizon.

She'll need to check whether that amount is sustainable, of course, as discussed here. By contrast, a retiree with a larger share of her cash-flow needs coming from certain sources of income, say a retired college professor with a full pension, would have a lower spending rate and, in turn, a lower allocation to safe assets. Assuming both portfolios were the same size, Karen's portfolio would be a lot more aggressive. Of course, that also assumes that Karen is OK with the swings that will inevitably accompany her aggressive portfolio; that may or may not be the case.

Misconception 2: You spend from the buckets sequentially. Once you've segmented your portfolio by your anticipated spending horizon, you need to have a system for maintaining those allocations an ongoing basis. One common point of confusion on this front is that you'll "spend through" the buckets sequentially--that is, you'll spend your cash first, then move onto short- and intermediate-term bonds, while saving stocks for last.

That makes a certain amount of sense, in that cash is the safest asset for very short time horizons, bonds have historically been quite safe assuming you have a time horizon of at least five years, and stocks have been pretty reliable for time horizons of 10 years or longer. First, such a strategy would leave a retiree with an increasingly aggressive portfolio. True, research conducted by financial planning experts Michael Kitces and Wade Pfau suggested that an asset allocation that grows more aggressive with time can help retirees avoid "sequence of return risk"--encountering a bum market early in retirement.

But an increasingly aggressive portfolio might create behavioral challenges, as many older retirees prioritize being able to sleep easily over growing their nest eggs. Perhaps more important, spending down cash and bonds first has the potential to leave an investor with a very aggressive, stock-heavy portfolio at a time when it's not opportune to draw from it because stocks are depressed. For that reason, I like the idea of using income and rebalancing proceeds to help supply liquidity to the portfolio on an ongoing basis.

Rebalancing to a target allocation also serves to keep the portfolio from skewing to a single asset class over time, as depleting the buckets sequentially would tend to do. It also allows you to be opportunistic in terms of where you turn for cash flow in a given year.