Many of us fear running out of money in retirement. And because none of us knows how long we will live or whether the stock market will rise in a bull market, or fall in a bear market immediately following retirement, determining how much you can safely withdraw from your savings and how much you should maintain in cash should be carefully considered.
On top of the usual retirement spending concerns, the recent high inflation and market volatility have many retirees or professionals approaching retirement nervous as they see their savings fall in value while also losing purchasing power in the short term. According to Evensky, investors tend to panic during market downturns and sell their stock and bond holdings entirely, locking in losses and potentially dragging down their investment returns for years to come, if not potentially permanently destroying wealth they will need 10- 15 or 20 years down the road. Retirees can avoid selling into a down market by knowing they have enough cash to meet immediate expenses.
Enter the bucket strategy. First popularized by financial advisor Harold Evensky in 1985, the bucket strategy divides retirement income into three buckets – one for short-term daily lifestyle expenses and financial needs, another for intermediate needs, and a last for expected and assumed long-term retirement expenditures. The simplicity of the bucket strategy has helped it endure as a planning strategy for more than 30 years.
Ideally, keeping your short-term money for retirement needs in cash will ease your worries about day-to-day and week-to-week stock market fluctuations and prevent you from needing to sell investments during market downturns.
Investing Money in Your Retirement Buckets
Here’s a breakdown of how you might invest the money in each bucket:
Short-term bucket: You should hold cash or similar investments such as FDIC-insured money markets or online high-yield savings accounts in this bucket. The goal is to keep money that can quickly be converted to cash when you need to spend it without the risk of losing principal.
To determine how much cash you will need each year in retirement, estimate your monthly expenses plus your estimated taxes for the year, and subtract your Social Security benefits and any other guaranteed income such as a pension or annuity. So if you need $50,000 in cash each year, look to keep as much as $100,000 in the short-term bucket as a two-year cash reserve strategy.
Of course, each retiree’s cash reserve should be customized to their plan, risk tolerance, and guaranteed income stream. For example, a client with a pension and annuity income of $100,000 annually with total lifestyle expenses of $150,000 might choose only to keep cash of $50,000. In contrast, another retiree with only $50,000 of pension income and the same level of lifestyle expenses might elect to maintain two years of cash reserve, or $100,000, on hand due to having a higher annual distribution need from their portfolio.
Intermediate-term bucket: This bucket should cover expenses you’ll have in a 3 to 7-year time horizon. With a longer timeline, you’ll be able to hold some moderately risky investments in this bucket, including investment grade short-term corporate bonds, longer-term CDs (if interest rates relative to inflation are attractive), growth and income funds, and preferred stocks as examples. But, again, consider opting for investments that keep pace with inflation over the long-term without taking too much risk.
Long-term bucket: Because you may live 20 to 30 years or more in retirement, some (likely a good portion!) of your retirement savings needs to be invested in growth assets like stocks. In your long-term bucket, intended to hold the money you won’t need for five to ten years or more, you can include stocks, both US and International, Emerging Markets, and longer-term and higher-yielding bonds that may carry more risk but can generate income and price appreciation for future spending.
Interest income from bonds, dividends from stocks, and raising cash by realizing capital appreciation through timely rebalancing of your portfolio (buying low, selling high!) can assist you in “refilling” the cash reserve bucket strategy on an ongoing basis. So as you spend money from bucket one in retirement, you replenish it with income and investment proceeds from the other two buckets. An experienced planner and fiduciary can help you create a plan and customized portfolio and cash reserve strategy to meet your needs and potentially improve your tax efficiency.
Don’t Fill Your Short-term Retirement Bucket to Overflowing
In a recent interview with Barron’s, Evensky disagreed with how some advisors today carry out the bucket strategy. According to Evensky, some advisors suggest keeping up to 10 years’ worth of living expenses in short-term and intermediate-term buckets. He counters that retirees keep one bucket for cash and another for long-term investments. Furthermore, he asserts that keeping a year’s worth of money in the short-term bucket is enough to protect investors from market volatility, adding that holding more than that will drag down returns. Again, each retiree’s plan will differ based on individual fact patterns and goals – the bucket and cash reserve strategy is not a one size fits all approach.
Evensky maintains, and we agree, that not placing too much money into your short-term bucket with current high inflation rates is essential. Interest rates on savings accounts and short-term debt are rising but still running well below the inflation rate. That means the buying power of the cash in your short-term cash is declining over time.
The Bottom Line
Turning your retirement nest egg into a source of income that can last 25 to 30 years or more after your working years can be challenging to navigate on your own. A financial advisor can help you break down how much you can expect to spend in retirement, how to maximize income from Social Security and other sources, and whether the bucket strategy or another spending approach will be right for you.
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