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There have been many improvements in the world since I graduated from Warsaw Community High School in 1987. Back in those days, we didn’t have the internet or cell phones or flat screen TVs. I got an Apple IIc computer for graduation as I headed off for Indiana University. The Apple Watch I wear today is literally 8,000 times more powerful.
Retirement income generation has not improved like technology has. The average 6-month CD rate on Sept. 1, 1987, when I was a freshman at IU, was 6.79%. For the decade of the 1980s the average was 13.4%. (Source: Bankrate.com) Lower rates bring difficult decisions for those in or nearing retirement. You can work longer, save more, reduce your standard of living or take on more risk. But, even after the historic increase in rates by the Federal Reserve over the last few years, rates are still low by historical standards.
In addition to lower rates, today’s retirees must cope with the near-total disappearance of private-sector pensions. With all these factors, generating an income stream has never been more challenging. The bucket approach is one way to address these challenges.
The bucket approach is an asset allocation strategy that divides your retirement resources into three pools, or buckets, based on when you will access the money.
The first bucket is for your living expenses in the current year. Just take the amount you need to generate from your retirement savings each month and multiply by 12 for the amount you should have in the first bucket.
Determining the amount needed is accomplished by taking your monthly spending and subtracting your other sources of income like social security and pensions. This pool should only be invested in very stable investments like savings accounts, money market accounts and short-term CDs. Liquidity and stability are the most important considerations for this bucket. Even though these assets are liquid, this account should not be considered a replacement for your emergency fund.
The second bucket contains your spending money for the next four or five years. One way to invest this money is in a “ladder” of CDs or treasury notes, with one maturing each year for the next four or five years. This bucket can be invested slightly more aggressively than the first one, but you don’t want to stray too far. With this bucket as with first, the most important thing is that it is liquid when you need it, and that the value is stable. At the end of year one, you will use this pool to refill the first bucket.
The objective of the third bucket is to grow the portfolio over time and use the profits to replenish bucket two. Investments in this bucket can be more volatile, like stocks and longer-term bonds, so it may have a down year every so often. However, the point of segregating the longer-term assets is to make it easier to accept those declines and allow time for the investments to recover.
We want to avoid tapping into this bucket during slumping markets, and hopefully the long-term nature of this bucket will reduce the temptation to try to time the market.
We want to be able to increase our income over time, so it is important that we can keep pace with inflation to maintain the purchasing power of the portfolio. It is also important to rebalance the portfolio to prevent the equity portion from becoming too large and exposing you to more risk and volatility than you intend.
The bucket structure requires periodic maintenance, such as moving assets from bucket two to bucket one to cover the next year’s spending and moving profits from bucket three to bucket two to keep five to six years worth of spending in relatively stable investments.
Some investors prefer to actually segregate the buckets into three different accounts. This may add clarity but is not necessary. As with most aspects of investing, the bucket approach will take discipline to work to its fullest potential.
Important Disclosure: Mike Bergen is a Partner, Managing Director at Beacon Pointe Advisors, LLC. The information contained in this article is for general informational purposes only. Opinions referenced are as of the publication date and may be modified due to changes in the market or economic conditions and may not necessarily come to pass. Beacon Pointe has exercised all reasonable professional care in preparing this information. The information has been obtained from sources we believe to be reliable; however, Beacon Pointe has not independently verified or attested to the accuracy or authenticity of the information. The discussions, outlook, and viewpoints featured are not intended to be investment advice and do not consider specific investment objectives or risk tolerance you may have. All investments involve risks, including the loss of principal. Asset allocation does not ensure a profit or protect against loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk. Rebalancing a portfolio may cause investors to incur tax liabilities and/or transaction costs and does not assure a profit or protect against a loss. Bonds are subject to market risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price. Consult your financial professional for guidance specific to your circumstances.
