Using the Bucket Strategy for Retirement Funds

Most retirees know what a bucket list is: that compilation of once-in-a-lifetime opportunities a person wants to experience before they kick the bucket.

A few years ago, financial planners started talking about a bucket strategy. Certainly not as well known as the bucket list, the bucket strategy for managing retirement savings has steadily gained in popularity.

Here is a quick primer on the bucket strategy:

What is the Bucket Strategy?

The bucket strategy is actually a combination of five different strategies, each geared to a specific period of your retirement. The goal of the bucket strategy is to hedge against the possibility that you will outlive your retirement savings. The bucket strategy is utilized for active retirement fund management. It is not a strategy for saving for retirement.

How Does it Work?

Typically¸ retirees manage their retirement funds as a whole, rebalancing periodically in consideration of changes in risk tolerance and other factors.

With the bucket strategy, retirement funds are divided into four or five different buckets from which retirement funds will be drawn at different times.

The first bucket will hold monies to fund the first five years of retirement. Since this bucket is going to be drawn from immediately, the funds managed must be extremely liquid. Limit investments to certificates of deposit, money market accounts, and short-term annuities.

The second bucket, which will fund retirement years 6 through 10, should be comprised of longer term certificates of deposit, short-term treasury notes or inflation-indexed securities . Risk should still be extremely limited for investments residing in the second bucket.

Bucket #3 holds funds for years 11 '" 15 of retirement. At this point, tolerance for risk rises slightly and investments can begin to be a bit more aggressive. By holding solid stocks, mutual funds, or investment grade bonds, the retiree can seek a higher return on his third bucket investments as he has a bit more time to recover from any market losses.

Retirement years 16 '" 20 will be funded from bucket #4. Increasing the risk again slightly for this bucket, retirees can look at a greater portfolio share of stocks, bonds, and deferred annuities.

The final bucket, #5, is reserved for funding years 20+ of retirement. Since these funds should not be needed for two decades or more, the risk tolerance is greater than in any other bucket. This money can be placed in insurance instruments, growth stocks, and other investments that have historically provided greater returns over the long run.

As the retiree passes year 5, money should be moved from bucket 2 into the liquid investments of bucket 1, move investments from bucket 3 into the safer instruments of bucket 2, bucket 4 monies move to bucket 3. After the fifth year of retirement, bucket 5 should be eliminated as those funds become bucket 4 investments.

The liquidity of investments in buckets 1 and 2 provide much needed security for the retiree and protect against the need to liquidate stocks during a temporary downturn in the market. The riskier investments in buckets 3, 4, and 5 provide an opportunity for a greater return and that all important hedge against a retiree outliving his savings due to investment growth not keeping up with inflation.

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