Many investors worry about the possibility that they would outlive their money during their senior years. Indeed, it would help if you stayed invested in stocks in your retirement years to maintain growth in some parts of your portfolio even as you rely on those investments to live.
However, if a major market slump occurred during your retirement, deciding to sell your stocks and other holdings while their values are lower would only raise your risk. Remember: buy low, sell high.
Not having any stocks also have its repercussions. If your portfolio fails to outperform inflation, you may run out of money even before your time in this world comes to an end.
If you need a strategy that will allow you to invest for growth while protecting the money you need in the near term against volatility, the bucket strategy is one technique you can use.
The Bucket Strategy Explained
The bucket strategy is an investment approach that allocates your retirement money into three different holdings or buckets based on when you plan to tap on them.
The concept behind this strategy is that you should have cash available to use in the short term, so you don’t have to be afraid of stock market fluctuations.
Theoretically, you shouldn’t sell your holdings during market declines just to fund your annual withdrawals. The three buckets are topped up by interest income, dividends, and your investments’ performances.
How the Bucket Strategy Works
The Short-Term Bucket
The first bucket contains cash and other liquid investments, such as a high-yield savings account and short-term certification of deposits (CDs).
These investments are intended for your short-term financial obligations and should be liquid, so you can convert them into cash immediately when the need calls for it. They are not meant to be invested for growth and should be kept in your bank account.
Earning interest on this money is excellent, although the first bucket mainly aims to minimize risks and ensure that you always have cash on hand. Ideally, this bucket should cover two years’ worth of expenses.
The Medium-Term Bucket
The second bucket focuses on meeting your medium-term financial goals. This bucket should have enough money to pay for three to ten years of your retirement. The money here can be invested and should maintain its growth to keep up with inflation.
However, you need to avoid investing in assets that are often exposed to value fluctuations. Instead, fixed-income investments, such as CDs and bonds, are more suitable options for the money in this bucket.
The Long-Term Bucket
The third bucket will hold the money you will invest for the long term. It is the money that you plan to put in instruments like stocks and other related assets to gain higher rates of return in the long run.
So if, for instance, a market crash occurs during your retirement, you will be able to stay invested in stocks for a pretty long time, which should provide your portfolio enough time to recuperate.
So as the first bucket loses money, you fill it up with the money you generate from the second bucket, which should be replenished by moving money from the third bucket.
With the long-term bucket, you can invest in riskier assets with more than ten years of growth potential. Additionally, this bucket should hold a diversified portfolio of investments ranging from domestic to international, from small-cap to large-cap.
