Over the last few years, so-called bucket investment strategies have received increased attention by researchers and investors alike. It may be that it could work well for your portfolio. We’ll delve into the definition of bucket strategy and work through an example to see if it may be a good fit for you.
Dave Gardner
The image of buckets certainly does not evoke a hot, new investment concept. Something as pedestrian as a bucket hardly has the same vibe as a meme stock or non-fungible token (remember those?). Simply put, a bucket strategy is a method of dividing up your investment portfolio into different accounts. Each of the different accounts (or buckets if you will), has a different purpose or goal associated with it.
Splitting your investments between different accounts is nothing new. After all, many of us have investments that are pre-tax (such as a traditional 401(k) or IRA), tax-free (such as a Roth), and taxable (such as a savings account or taxable investment account).
The bucket strategy is more about the purpose of a given account rather than the actual type of account. This is perhaps best illustrated with an example. Let’s imagine Rick (aged 65 years old) is about to retire after a long career. He has $600,000 in his 401(k) at work. He hasn’t paid too much attention to it before now, other than choosing a target retirement fund as an investment and regularly contributing to it every year through work, along with an employer match.
But now that he’s about to retire, he’s wondering how he is going to take his 401(k) balance and make it into a series of monthly payments that will continue the rest of his life. This latest market decline has him spooked as it’s the second bear market in the last three years. While he was fine ignoring the markets as he was putting money into the 401(k), he now looks to withdraw from his retirement plan and the recent volatility leaves him uneasy to say the least.
Rick plans to wait until age 70 to take Social Security, as his benefit will grow 8% a year from his normal retirement age until the maximum benefit is reached. But he needs a way to bridge the income gap between now and when his Social Security benefit of $3,000 a month starts. Rick can roll his funds from a 401(k) directly into a traditional IRA with no tax consequence once he retires. While there may be advantages to leaving his assets there, having a traditional IRA that can be held at a custodian, like Schwab, Fidelity, or Vanguard, could give him a greater ability to select the investments that are best suited for him.
Rick sets up an IRA account at his favorite custodian for bucket number one, let’s call it the short-term bucket. This will be used to help him pay his bills over the next three years or so. He doesn’t want a lot of volatility in this account since it will be his income while he’s waiting for Social Security. In this IRA account he moves $126,000 from his 401(k), which is equal to $3,500 a month for the next 36 months.
Once this IRA is funded, he purchases Treasury bills or a money market fund with one third of the account to fund regular withdrawals of $3,500 a month over the next year. With the remainder of his short-term bucket IRA, he purchases a Treasury bond that matures one year from now, and another that matures two years from now. He could also use ETFs and mutual funds to achieve the same strategy.
Rick is planning on $3,500 a month withdrawals from his IRA because he will be withholding federal and state income tax on the distributions. These withdrawals are taxable as ordinary income, although there are some nice tax breaks for certain state taxes. Once these taxes are withheld, he’s left with $3,000 a month going into his checking account.
The remainder of the 401(k) is put into a second IRA as the investment bucket. Rick invests this account in a 60% stock and 40% bond portfolio using the ETFs or mutual funds of his choice. This account will be more volatile, and Rick will need to be prepared for a portfolio like this could decline up to 30% in a horrible bear market, such as the Global Financial Crisis of 2008-2009. In return for taking more risk, Rick’s expectation is that he will see higher potential growth in this bucket over time than the short-term one.
Astute readers will recognize that the short-term bucket will gradually decrease as you take distributions to fund your living expenses. To address that, every year Rick will transfer another $42,000 from the investment bucket IRA into the short-term bucket IRA. Once those funds are moved into the short-term bucket, he will use those funds to purchase another Treasury bond that matures in two years. He will repeat this process every year at least until his maximum Social Security benefit kicks in.
As you might imagine, there are many ways to implement the bucket strategy and solve additional complexities once you introduce different types of accounts, a spouse, pensions, and other considerations. This example provides a taste of a bucket strategy. Speak with a qualified financial professional to see if this is an option that could provide financial independence as you become reliant on your investments to fund your retirement spending.
David Gardner is a CERTIFIED FINANCIAL PLANNER professional at Mercer Advisors practicing in Boulder County. The opinions expressed by the author are his own and are not intended to serve as specific financial, accounting, or tax advice. They reflect the judgment of the author as of the date of publication and are subject to change. The information is believed to be accurate but is not guaranteed or warranted by Mercer Advisors. Content, research, tools, and stock or option symbols are for educational and illustrative purposes only and do not imply a recommendation or solicitation to buy or sell a particular security or to engage in any particular investment strategy. This presentation is not a substitute for a client-specific suitability analysis conducted by you and your advisors. You and your advisor must determine the suitability of a particular investment based on the characteristics and features of the investment and relevant information provided by you, including, but not limited to, your existing portfolio, investment objectives, risk profile, and liquidity needs. Investments mentioned in this document may not be suitable for all investors. The hypothetical example in this article is for illustration purposes only. Actual investor results will vary. For financial planning advice specific to your circumstances, talk to a qualified professional at Mercer Advisors.
Mercer Global Advisors Inc. is registered with the Securities and Exchange Commission and delivers all investment-related services. Mercer Advisors Inc. is the parent company of Mercer Global Advisors Inc. and is not involved with investment services.