The Bucket Strategy

I wish I had a dollar for every time I’ve been asked:

“Tony, how can I get high levels of income and growth without taking much risk?”

Let’s start with a reality check – you can’t!!

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​You don’t get high returns without bearing some painful losses along the way. You cannot achieve perfect safety without accepting low returns.

History has shown however that in time, markets recover and reward the patient investor.  So there’s no real damage done, as long as you have time on your side.

This is tricky when in retirement, as you don’t stop eating just because markets have gone temporarily mad (a bit like right now). You still need to draw a pension. This means that with the traditional superannuation pension, you’ll be selling low to fund your regular income. And in the years just either side of your retirement, that can be devastating.

This is known as sequencing risk and is an important concept. Read more about it here.

Blog Post - Beware The Red Zone

One potential solution is a retirement “bucket strategy”. This approach establishes different ‘buckets’ or accounts for different types of spending and investing over the entire period of your retirement.

Bucket strategies are designed to balance the need for income stability in the short-term and capital growth in the long-term.
 
The bucket approach divides your retirement into different phases, with a separate account established to meet your financial needs as you age.

A simple three-bucket retirement strategy, for example, divides your retirement savings into three accounts (short, medium and long-term), each of which has a different role:​

1. Short Term Bucket

​This is the liquid component and is designed to meet your near-term living expenses for the next 2–3 years. It’s not designed to provide big investment returns, but to hold the capital to meet your financial needs not covered by other income sources.  

Your cash bucket provides peace of mind you can pay your short-term expenses and ride out market volatility without needing to sell your long-term investments.

2. Medium Term Bucket

​The second bucket provides income and stability for your retirement portfolio. Income from this bucket is used to refill the short-term bucket as the assets in it decline. These are typically conservative investments too.  A small component may be allocated to quality, dividend paying shares.

3. Long Term Bucket

​The third bucket is designed to grow, helping ensure your retirement savings do not run out.

The investment returns from this bucket are likely to fluctuate over the short to medium-term. The assets in this bucket are not sold if the market declines but are held over the long-term and ride out any return volatility.

Drawbacks To The Bucket Strategy

​Using the bucket strategy to manage your retirement savings is not for everyone. As with any investment strategy, this approach has some issues you need to consider:

1. Managing It Can Be Tricky

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​​A bucket strategy is generally not set-and-forget. Maintaining the various accounts and keeping the right amount of money in each bucket can be time consuming. You also need to establish rules for when and how you will replenish your buckets and what you will do with returns if your investments do better (or worse) than expected.

Most people will need an adviser to manage this process.

2. Unsuitable For Conservative Investors

A bucket strategy may not be right for retirees with a conservative risk profile. When interest rates are low for your cash bucket, you must be prepared to invest in riskier assets in buckets 2 and 3. If not, the strategy may not work as your savings will not be growing enough to replenish your first bucket.

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This is by no means the only approach.  I have other clients who just invest in growth investments (shares and property) that pay dividends or rent.  If shares go down, or they are without a tenant for a while, they just tighten their belt a little. You need to be quite an aggressive investor for this approach.
 
And there are other options too. It's horses for courses.

Key Thoughts

• Sequencing risk is the risk that the order and timing of your investment returns are unfavourable, resulting in less money for your retirement. 
• Sequencing risk is greatest in the years just either side of retirement
• A bucket strategy is a way to avoid selling growth assets when investment markets are down, resulting in your nest egg lasting longer​

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IMPORTANT ​This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each individual and investor are different and you should not act on this information without speaking to a financial, tax or legal adviser, who can consider if the financial product and strategies are appropriate for you. To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information. See full Terms and Conditions here.