Use the 3-Bucket Strategy to Fund Your Retirement

Knowing how to implement the bucket strategy could help you grow and safeguard your retirement funds.

Diversifying and prioritizing different income streams can help stabilize your cash flow. New Africa/Shutterstock

You’ve worked hard to save and accumulate a retirement nest egg. Part of generating this income is safeguarding it from the volatility of the market, changing tax laws, and longer life expectancies. Using the bucket strategy will help secure your retirement.

But what is the bucket strategy? It’s a strategy that diversifies and prioritizes different income streams to stabilize your cash flow. Knowing how to implement it could help you grow and safeguard your retirement funds.

3-Bucket Strategy Splits Investments

The three-bucket strategy divides investments into these categories: short-term, intermediate-term, and long-term.

This provides protection against market fluctuations. It allows money from more conservative or cash-like investments to be drawn down during a down market.

The goal is to preserve money held in more risky investments, like stocks.

The three-bucket strategy can be customized based on your needs.

Short-Term Bucket Used for Immediate Needs

According to U.S. Bank, the short-term bucket is for immediate needs. These could be for living expenses like mortgage, groceries, utilities, etc. Social Security would go in your short-term bucket.

But, according to Peak Financial, from an investment strategy, the short-term bucket is focused on low-risk assets (cash equivalents) with short maturities. Examples of these would be cash savings accounts, certificates of deposit (CDs), and money markets.

Income must be protected from the market while remaining accessible as an income source.

Plan on positioning between one to five years of expenses in low-risk cash equivalents.

Intermediate-Term Bucket Used for Short-Term Savings Goals

The second bucket may include money to fund nonessential or unforeseen expenses. These could be a trip, a new car, a grandchild’s education, etc.

Money in the intermediate should be invested in conservative to moderate risk investments. The investment must at least match inflation.

This could include two- to 10-year maturity bonds, longer-maturity CDs, preferred stock, dividend-producing stocks, and real estate investment trusts (REITs).

The goal is to match or outpace inflation without taking on a large risk. You want to protect the principal.

Long-Term Bucket Used for Later Retirement Years

After 10 years, you may think about long-term goals. You may be considering assisted living or long-term care. Many think about the legacy they'll leave their children. This bucket is geared toward long-term growth.

The long-term bucket is higher risk. Your money is invested looking at 10-plus years. This should provide you with significant growth.

Investments would include:

• growth stocks
• small-cap stocks
• emerging market stocks
• high-yield bonds
• index funds (i.e., those which mimic the Nasdaq Composite or S&P 500 indexes, e.g.)

But funds don’t stay in the bucket for the duration. The long-term bucket is used to refill the intermediate-term and short-term buckets as they’re drained.

Implementing the Bucket Strategy

To implement the bucket strategy, you need to start by estimating your retirement expenses. Just figure out what your expenses are now. If you plan on downsizing, factor that into your calculations.

Add the inflation factor into your expenses. You might want to consult a fee-only fiduciary financial advisor for this.

Once you’ve determined your expenses, it’s time to start funding the buckets.

According to Schwab, the buckets should be funded in years and include:

• Short-term bucket: 0–5 years
• Intermediate-term bucket: 6–10 years
• Long-term bucket: 11 years+

Remember, the short-term bucket needs to be in cash or cash equivalents.

For example, if you need $30,000 a year to live. Fund the first zero to five years with $150,000.

Your intermediate of six to 10 years will be based on portfolio allocation, while the long-term of 11 years or more is also based on portfolio allocation.

If you have $500,000 in your retirement fund, take the $150,000 out that goes to your short-term bucket and divide the rest between the intermediate and long-term bucket. It doesn’t have to be even. But ensure you plan for future needs.

Rebalance Your Buckets Frequently

Don’t let your buckets become lopsided. Ensure you work with a fiduciary financial adviser who can help you reallocate funds as they grow.

Your long-term bucket may need funds moved to your intermediate-term bucket. This is especially true as you advance in retirement.

Pros of the Bucket Strategy

The bucket system allows you to navigate market downturns without decimating your investments. You’re balanced, and it creates a predictable and stable retirement plan.

This is an organized strategy that simplifies a complicated issue. Your investments are made according to how you live your life.

Cons of the Bucket Strategy

Managing your buckets can take time and effort. It’s a conservative strategy. It may be difficult for you to watch a soaring market when you have substantial amounts of cash uninvested.

The three-bucket strategy may also be limited depending on your wealth.

The Strategy Requires Planning

The retirement bucket strategy divides your income into three buckets. It holds assets with different levels of risk and liquidity based on the money needed during your retirement.

The goal is to ensure a consistent income stream during retirement while at the same time protecting your nest egg from market volatility.

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