The Bucket Approach to Retirement Investing

Imagine you have a bucket. Make it a BIG bucket. In this bucket is all the money you’ll need to withdraw from your retirement account(s) for the next two or three or five years.

You’d feel pretty secure financially, wouldn’t you?

Plenty of retirees have that secure feeling because they’re using something called “the bucket approach.” Those nearing or entering retirement should give it serious thought. It’s worked for us, and I’d like to show you how it might work for you.*

A Quick History of Stocks

If you’re ten years from retirement, there’s little reason to not be invested in stocks. Over the past 30 years, the S&P 500 has returned an average of 9.7% annually.** That’s not a guarantee. Some years are less, and you could suffer declines in your account value. But other years you could gain more. While past returns are never a guarantee of future returns, it’s the best indicator that we have.

If you’re closer to retirement, you need to ask yourself some questions. How much will you need to draw from your retirement account in the year after you retire? How about the years after that? It’s in the final few years before retirement that the bucket approach comes into play.

The Markets and Your Mind

The mind typically thinks all or nothing in terms of being invested. This is reinforced by media pundits who seek attention by predicting doom or prosperity. If the market goes into a decline, there is the temptation to put all of your investments in a Money Market Fund and ride out the downturn. I’ve done it, so I know there’s an immediate feeling of relief that your account value stops declining. That relief usually doesn’t last very long.

The problem with selling everything is it almost always locks in a big loss and then misses out on big gains. In fact, the biggest gains in stocks often come in the first couple of weeks after the market reaches the bottom. And no one will realize where the bottom was until months into a market recovery.

Bucket Approach Basics

With your money in buckets, you no longer have to worry about being “in” or “out” of the market. You’re increasing your ability to weather a market decline while staying on track with your overall investment strategy.

When using this approach, you create a bucket of investments for each era of your retirement life. The money you’ll need in the near future is kept in a “safe” bucket. Money you won’t need for years to come can be invested in other buckets aiming for more aggressive returns. Having that safe bucket can prevent you from panicking in a market downturn.

Without a Bucket

Let’s say you plan to take out $30,000 a year in retirement. A 30% decline in your investment accounts at the time you begin your withdrawals could make that $21,000. Ouch! This is called ‘sequence risk.’

Worse, if your account value declines 30% and you still need to withdraw that $30,000, you’ve lost the future returns on an additional $9,000. Over a 30 year retirement, that $9,000 could have grown to over $144,000 – using that past 9.7% S&P 500 average as a guide.

Double Ouch!

Bucket #1

This is your safety bucket. It’s also your withdrawal bucket. This is where the money comes from that you’re living on. Instead of letting that $30,000 stay invested in stocks or bonds and perhaps suffer a big decline, the money is placed in this bucket with your safest investment options – usually CD’s or Money Market Funds. You won’t make a lot of interest here, but you’ve eliminated the possibility of a sudden drop, just when you need the money.

Depending on how conservative you want to be, you may want more in your safety bucket. Some people are happy with one year, some three years, and a few choose to have five years worth of planned withdrawals in this bucket.

We settled on three years. This was our reasoning.

Bear Market History

There have been 12 Bear markets since World War II. On average, it takes about two years to recover from a Bear. The 2007 Bear market was a bit of an outlier as stocks took about four years to make new highs (that Bear actually started a year before the 2008 market collapse). So for us, three years seems reasonable. This would keep our planned withdrawals safe while allowing the rest of our investments to go through a fairly severe Bear market.

One year into retirement the safety bucket paid off for us when the Coronavirus hit. It would have been tempting to pull all of our investments out of the markets (like I did in 2008). But we were able to let the investment cycle run its course because we knew we already had everything we needed for three years in our safety bucket.

The result? Our account values fully recovered in six months, and even started registering gains.

Now, what happens if you’re invested in stocks and they don’t recover? Well, up to this point in history, stocks have always recovered. It’s simply been a matter of how much time it takes for that to happen. If there comes a day when stocks don’t ever recover, I’m guessing we’ll all have much bigger worries.

Your Other Buckets

If you settled on a three year timeframe for Bucket #1, perhaps bucket #2 is money you won’t need for another five years after that – years four through eight. That money can be invested more aggressively – say a 60/40 or 70/30 stocks/bonds mix. A final bucket could be money you won’t need until nearly a decade from now, and could be invested more aggressively still. These are things to discuss with a good fee-only financial planner, who will take the time to analyze your risk tolerance before developing your plan.

For us, it’s just two buckets. The safe one, and an aggressive one.

Refilling Bucket #1

So the question becomes, when do I refill my first bucket?

Let’s say you settled on a three year “safety net” in bucket #1. With your first withdrawals your bucket is starting to drain. But if you always kept exactly three years of planned withdrawals in that bucket, you’d simply be pulling the same amount from your investments each month to refill the bucket. And if the market is heading down, that defeats the purpose of not withdrawing money at its low points.

So this becomes an issue with having the determination to refill the bucket as the market is rising. That’s tough to do when things are going good, but it’s exactly when you need to be taking advantage of those market highs to make sure you can ride out the lows.

Overall Investment Returns

Some studies have indicated the bucket approach may not deliver the long-term returns that you’d have if you just stayed fully invested at all times. Theoretically, that may be true. But we don’t live in a theoretical world, we live in a world where human emotion is constantly at play. Seeing your account value drop day after day after day can cause you to panic.

The bucket strategy is meant to give you reassurance when you’re likely to need it most. It worked for us, and it may be just what you need to sleep peacefully the next time the market rollercoaster heads straight down.

*We are not financial planners and not recommending specific investing advice. We always recommend seeking professional advice tailored for your unique situation. Listed below are places to search for a Fee-Only Financial Planner and to check their status.

** June 1990-June 2020