Rosalind Evans
Planning for retirement isn’t solely about accumulating wealth — safeguarding your hard-earned money is equally crucial. The ‘bucket strategy’ can be a valuable tool in achieving this.
Recall the seemingly effortless success of retirement planning. It appeared that all you needed to do was watch your 401(k), Roth IRA or brokerage accounts grow exponentially.
This was a common perspective during the historic bull market from 2009 to 2020, making nearly everyone feel like a savvy investor.
However, the financial turbulence of 2020 served as a reality check. It reminded us that market cycles are inherently unpredictable. Although the market rebounded swiftly following the initial COVID-induced plunge, it’s been fraught with instability.
This continuous market uncertainty should be a wake-up call to all savers. Planning for retirement extends beyond wealth generation — it encompasses safeguarding your existing wealth too. This message is particularly pertinent for those who have recently retired or are considering retirement. The stock market’s performance, particularly the sequence of negative and positive returns, can significantly influence the sustainability of your savings as you commence portfolio withdrawals.
For instance, if your retirement begins with a downturn and you need to sell your assets for income, it can lead to two potential outcomes. You might have to offload more shares at a lower price to obtain the funds you need, and consequently, you’ll have fewer shares to profit from potential positive returns in the future.
Suppose you heavily rely on your portfolio for retirement income and cannot adjust your withdrawal amount. In that case, you may withdraw more during the initial market downturns than what can be recouped in subsequent profitable years. Consequently, your portfolio might be depleted quicker than anticipated.
This phenomenon is known as the sequence of returns risk.
Preparation for this specific retirement risk can be challenging since it largely depends on unpredictable market movements. When individuals select a retirement date, they cannot predict the global and U.S. markets’ performance in the ensuing years.
For example, those who retired in 2010 or 2011, shortly after the onset of the historic bull market, were fortunate. However, those who retired a decade earlier faced continuous financial hardships — initially due to the dot-com bubble, followed by 9/11, and ultimately the Great Recession of 2008.
So, how can you enhance your fortune?
While we can’t offer crystal balls or tarot cards to predict your financial future, you can adopt specific strategies to insulate your portfolio against poor retirement timing.
One such strategy involves segregating your assets into three distinct investment “buckets”: a cash/emergency bucket, a protected income bucket, and a growth bucket. Here’s how it works:
Cash/emergency bucket:
It’s wise to allocate at least six months of living expenses to this bucket. In case of unforeseen personal or market events, this will prevent you from having to sell your stocks to fund your retirement, ensuring budgetary control.
The cash in this bucket, which can be placed in high-yield savings or money market account to accrue reasonable interest, can be utilized for substantial repair bills, medical costs, and other unexpected retirement expenses.
Protected income bucket:
This bucket will be your primary withdrawal source during the initial decade or so of retirement. Hence, it should contain investments known to yield reliable income. The bucket’s size, essentially the most substantial, may depend on your projected Social Security benefits and pensions.
Fixed-index annuities with no caps or fees are one of my preferred choices for this bucket. They can serve as alternatives to problematic bonds in retirement portfolios, offering protection against losses, potentially better returns than bonds, and aiding portfolio diversification.
Growth bucket:
This portion of your portfolio will continue to generate money for the future (at least 10 to 15 years into retirement). It will help your savings keep up with inflation and can be used to refill your protected income bucket as it dwindles.
The assets in your growth bucket will depend on your age and risk tolerance and could range from equities and commodities to real estate investments and private equity/hedge funds. If you are comfortable with the market’s ups and downs and have surplus money, you might allocate a small percentage of this bucket to riskier or speculative investments.
You can adopt the bucket strategy anytime, before or after retirement. However, it’s generally advised to transition from an accumulation-focused portfolio to a preservation-oriented one at least five years before retirement. This gives you ample time for proactive planning with a proficient financial advisor. With this approach, you can avoid delaying your retirement or returning to work, even amidst significant market upheavals coinciding with your work cessation.
No strategy offers absolute protection against the market’s uncertainties, but the ‘bucket strategy’ provides a systematic, diversified approach to managing your retirement funds. It balances continued growth, income generation, and an emergency safety net. While luck certainly plays a part in any investment endeavour, strategic planning can significantly improve your odds. This means that despite any tumultuous start to your retirement, your savings nest doesn’t have to be prematurely drained. Working alongside an experienced financial advisor and implementing a sound retirement strategy like the ‘bucket strategy’ can go a long way in securing a comfortable retirement.
