Published May 04, 2012
As you plan for your future on the golf course or sail boat and tick items off your post-work bucket list, you could take the same strategy for the portion of your portfolio that’s budgeted for discretionary income.
Bucket strategies dedicate assets for certain periods in retirement, according to John Ameriks, principal at Vanguard. “The issue of making sure you have the resources to match your needs in retirement is very important.” The benefit of using a dedicated resource strategy is that you have to think about your needs and how your resources will fund your needs. “It makes you plan.”
Experts recommend a bucket list strategy for people who are retired and no longer accumulating wealth. “There’s a difference between a lifetime stream of income and a variable stream,” says Jean Setzfand, vice president for Financial Security at AARP. Lifetime streams include Social Security, traditional pensions, or annuity payments that are used to cover necessities like rent, food, and health-care costs. “These give people security because the checks will be there until death,” she says.
Most people don’t have pensions anymore and, instead, rely on retirement savings in accounts, like a 401(k), which don’t have guaranteed payments, says Setzfand. “Do the math between your guaranteed payments and your budget for necessities, and, if there’s a gap, you want to fill that gap with another form of lifetime income, like an annuity.”
When your necessities are covered, “everything else with regards to discretionary expenses is variable,” says Setzfand. “Once you’ve taken care of your basic living expenses, you can take more risk with your asset allocation for discretionary income.” A bucket strategy is one way to invest this income.
“The strategy is easiest when you separate your money into three categories: what you need now, what you need in the mid-term years, and what you need in the long-term,” says Certified Public Accountant Barry Picker. He adds that the easiest way to implement the strategy would be to have one account with securities matched to one of the three periods.
The money is held in one account, and, if there’s an emergency and you need money immediately, you won’t have to move money to access your cash. “You want as much flexibility and simplicity as possible,” says Picker.
When you invest your money with a bucket strategy, experts say the money that you’ll need down the road is able to withstand more risk. To implement the strategy, Will Smayda, Southern California regional sales manager for Merrill Edge, recommends holding money you plan to use during the next 24 months in safe investments, like cash or cash equivalents, that are shielded from market fluctuations.
The next bucket holds funds that you’ll need two to five years in the future. Since this mid-term bucket can withstand some risk, experts suggest holding diversified investments such as corporate bonds, notes maturing in five years, dividend yielding stocks, high quality domestic blue chip stocks, or mutual funds.
As you look to invest funds allocated for five years out and beyond, “this money has more time to weather the ups and downs of the market,” says Smayda. Experts suggest considering stocks for newer companies that pay less income, but have more growth potential, or international stocks.
“The challenge to a bucket strategy is that you can’t look at the buckets separately,” says Smayda. “They have to be designed together.” He recommends that investors revisit their plans at least twice a year and rebalance portfolios accordingly, which could be at least once a year.
For the most part, “this strategy protects investors against down markets because investors don’t have to sell in a down market,” says Picker. “Investments are scheduled to mature when you need to replenish the cash bucket. If stocks are down, you can replenish cash from fixed income or leave it and not replenish buckets until markets improve.”
“If everything goes as planned, bucket strategies work perfectly,” says Ameriks. There can be situations when investors need access to more cash than what they originally budgeted and you may lose money if interest rates don’t move in the right direction.
Emergencies are always a possibility, says Picker. “This strategy isn’t more complicated than any other strategy if an emergency comes up.”