By Dr. Jim Dahle, WCI Founder
The Buckets Strategy is a retirement asset allocation and spend-down strategy that you should certainly know about. It was popularized by Ray Lucia's book Buckets of Money: How to Retire in Comfort and Safety. You don't need to read a whole book to understand it, though.
Like any retirement asset allocation or spend-down strategy, the idea is to minimize the Sequence Of Returns Risk (SORR). This is the risk that despite having solid average returns on your portfolio over your retirement years, the crummy returns show up first and cause you to run out of money. Falling asset values combined with withdrawals that are too large can decimate a portfolio quickly.
What Is the Bucket Strategy for Retirement?
To understand the Buckets Strategy, you must first understand the “standard” way things are done. The standard way is to pick an asset allocation you can tolerate that is also likely to provide enough growth to meet your goals. You withdraw from the portfolio each year and then rebalance the portfolio back to the standard asset allocation you chose. This essentially causes you to withdraw from the asset classes doing well and perhaps even sell some of those high-performing assets to buy some low-performing assets when rebalancing.
The Buckets Strategy does not pick a set asset allocation. Instead, you allocate money by when it will be used.
#1 Short-Term Bucket
The short-term bucket consists of money to be used in the next 1-4 years, typically invested in cash or similar investments where nominal principal cannot be lost. Inflation is a risk, but it is minimal given the short time period. This bucket allows you to withdraw money from the portfolio to live on without having to sell any assets low in a bear market like 2022, where both stocks and bonds are down.
#2 Intermediate-Term Bucket
The intermediate-term bucket consists of money that will be used when the short-term bucket is exhausted, typically invested in bonds or a conservative mix of bonds and riskier assets. The idea behind this bucket is that it can be tapped in the event of a prolonged bear market where you have already exhausted the short-term bucket.
#3 Long-Term Bucket
This is the risk part of the portfolio. It is for money that won't be used for 7-15 (or more) years and is invested aggressively in stocks and real estate.
More information here:
The Best Way to Create a Retirement Income Plan (and a $1 Million Example)
An Example of the Bucket Retirement Strategy
Let me show you an example so you can see how this works. Let's say you've decided you're going to have three buckets and they're going to look like this:
#1 Two years worth of spending, all invested in a money market fund
#2 Five years worth of spending, all invested in a short-term TIPS ladder
#3 The remainder of the money, all invested in risky assets—split between stocks and real estate, none of which will be touched for the first seven years
Let's say you have a $4 million portfolio, and you plan to spend $100,000 per year. You're going to have the following assets in the following buckets:
#1 $200,000 in a money market fund
#2 Five $100,000 TIPS: a two-year, a three-year, a four-year, a five-year, and a six-year
#3 $1.65 million invested in stock index funds and $1.65 million invested in real estate
What is your asset allocation? It is:
- 41% Stocks
- 41% Real Estate
- 12.5% Bonds
- 5% Cash
That's pretty aggressive for a retiree. The “age in bonds” rule would suggest a portfolio that is more like 40/60, not 82/18. This buckets portfolio is far more aggressive than even the “age minus 20 in bonds” rule of thumb. The benefit of being aggressive is that your portfolio is more likely to keep up with inflation in the long term and you're likely to leave more to your heirs. The downside of being aggressive is that you can have a very big loss in the event of a bear market and that you might even panic and abandon the plan. Imagine this retiree had even more money. Let's say the portfolio was $6 million. Now, it's an 88/12 portfolio. The first two buckets aren't a percentage of a portfolio; they're simply the amounts you spend each year. What if the portfolio was only $2 million? Now, the asset allocation is 65/35. As you can see, it's no longer about the asset allocation; it's about the buckets.
Now What?
So far, so good. But here's where it gets interesting. Are you going to replenish those buckets, or just let them ride? If you just let them ride, you first spend your cash, then you spend your TIPS (one TIPS for each year), and then all that is left is your risky assets. If you retired at age 60, all you have left are risky assets by age 67. If you live to 97, you'll have a portfolio that is 100/0 for the last 30 years of your life. Everything you ever spend at that point will be exposed to the markets. I can't imagine a lot of people will sleep well with that portfolio.
OK, maybe instead you decide to replenish the buckets as you go. Let's say you rebalance the portfolio every year and refill your two buckets. Let's say it is a terrible year for stocks, and they lose 40% of their value. Now, you're selling stocks low to refill the buckets. What was the point of the Buckets Strategy again? Wasn't it to avoid selling low? Seems pointless now.
You need a guideline that tells you when to refill the buckets and when not to refill the buckets. Perhaps you decide you will not refill the buckets after any year that the stock market is down, but if the stock market is up, you will refill them all.
- Year 1: market up, refill all buckets
- Year 2: market down, no refilling. You now have one year of cash and five years of TIPS
- Year 3: market up, refill all buckets
- Year 4: market down, no refilling. You now have one year of cash and five years of TIPS
- Year 5: market down, no refilling. You now have five years of TIPS
- Year 6: market down, no refilling. You now have four years of TIPS
- Year 7: market down, no refilling. You now have three years of TIPS
- Year 8: market is up, refill all the buckets
- Year 9: market is up, refill all the buckets
- Year 10: market is up, refill all the buckets
Seems pretty good, right? You could “weather” a stock downturn of up to seven years before you had to sell stocks low. However, even selling stocks after one up year if it follows four or five down years might still be selling low. But the strategy seems pretty good. Bucket #1 loses zero nominal principal in a two-year bear market. Bucket #2 loses zero real principal in a seven-year bear market. If you started two years before retiring, you could even fund Bucket #1 with TIPS. When was the last time we had a seven-year bear market? It hasn't happened since we started keeping good records in 1927.
You can see a four-year period during the Great Depression, two years during the Stagflation of the '70s, and three years after the dot.com bubble burst. But that still gives you three more years to play with. The two years of cash would get you through most bear markets, and you would rarely get very far into the intermediate bucket. You could take it a little further even and only refill the buckets after two years of positive stock returns. That would give you a six-year period in the early 1930s, a five-year period in the late 1930s, a five-year period after World War II, and a five-year period after the dot.com bubble. Your seven-year cushion would still see you through just fine.
I really like this strategy. It addresses the sequence of returns risk and inflation risk quite well. It encourages retirees to take on an adequate level of risk, knowing that no money that they need any time soon is really at risk. If you are a particularly risk-averse investor, make the first bucket 3-4 years instead of two and the second bucket 7-10 years instead of five. Surely, at some point, you'll acknowledge you're going to be fine, while still investing the majority of your assets for the long run.
More information here:
How to Spend Your Nest Egg — Probability vs. Safety First
Other Kinds of Buckets
There is another way to incorporate buckets into your financial plan. You can bucket assets according to your financial goals and the purpose for the money. We realized a while ago that we're going to live the rest of our lives solely off of our taxable account and HSA. Why not start investing the other assets for where they're actually going to end up?
College Bucket
Retirement Bucket
Heirs
- Roth IRAs
- Roth 401(k)s
- Taxable account
Charity
- 401(k)s
- Defined Benefit Plan
- Donor Advised Fund
- Charitable Foundation
- Taxable Account
- HSA
Why are we still investing our Roth IRAs as though we're going to spend them? We're not. They probably won't be spent for 50+ years. So, why not invest them very aggressively? I'm 47. Nothing is coming out of those tax-deferred accounts for another 25 years, and even then, it will start at less than 4%. Why not invest those very aggressively? My risk tolerance goes way up once I know something isn't my money. I'm super risk tolerant with my kids' 529 money, so why wouldn't I be with money that I know is almost certainly going to charity? So what if they get a little less? Why not put it at risk and try to give them a lot more?
More information here:
Is Now a Good Time to Retire? Here’s What Christine Benz Thinks
A Word of Caution
A Buckets Strategy does not excuse you from making sure you're only withdrawing a reasonable amount from the portfolio in the first place. Let's say you're planning to spend $100,000 a year but only have a $1 million portfolio. That's a 10% withdrawal rate, a fool's errand per the Trinity Study—even with an aggressive portfolio.
You'd have $200,000 in cash, $500,000 in bonds, and only $300,000 in risky assets that you're supposed to live on for the last 23 years of your 30-year retirement. That $300,000 had better perform REALLY well that first few years. The data suggests you're going to run out of money two-thirds of the time in only 15 years, and it's just about guaranteed by 20 years. But if you're starting out at something around 4%, this should work just fine. You'd have 8% of your portfolio in cash, 20% in short-term TIPS, and 72% in risky assets.
What do you think? Would you use a Buckets Strategy of some type during retirement? What would your buckets look like and how would you refill them? Comment below!
I just retired and set up my portfolio in 3 buckets: 2 year cash, 3 years short term treasuries, 5 years Total Bond Market., the rest in Total Stock and Total International . Your buckets make more sense to me. Do I change my portfolio at this point?
Sure, if you want. But your plan is also reasonable. Staying the course with whatever plan you choose probably matters more than what the plan is, so long as the plan is reasonable.
Great buck strategy article! I read about it in other sources, but it wasn’t explained as well. Great job!
Thank you for your kind words. I like to think I’m getting better at this blogging thing over time.
Asset decumulation strategies like this seem ripe for a roboadvisor solution that can execute a plan automatically based on predefined parameters/rules, but I don’t remember them being discussed. Are they just not ready for primetime?
They don’t work well with multiple retirement accounts like most doctors have. They’ll manage your IRA and your taxable account, but probably not your 401(k).
This is sort of my strategy (not yet fulfilled) of a 5 year ladder of CDs to use or rotate if not needed on top of our pensions and the rest in stocks. However there’s still the cloudy crystal ball aspect of: when is a good year for the market? Since I have way too many separate mutual funds and of course can choose any time to sell, I just force myself to slowly fund that 5 year ladder and I choose whichever fund is no longer one we want to keep, so long as it is up over the past year and preferably has had a higher percent growth recently over the other funds. Also consider the capital gains owed and how much more money I’ll need to pay them, so basically have been trimming out the more recent ‘gee that’s a good diversifier’ purchases from before I was convinced simpler and smaller is better (for my heirs including spouse if I or my mind go first).
Once I actually have the 5 year ladder built I hope I will be willing and able to replace each (monthly) CD when it is used if not just rotated, but fear I will still look over recent returns and hold off if the market is not growing as quick in any year as the years prior. This article kindly reassures me that I can probably get away with doing that for a few years before that strategy costs us. And helps me ensure I properly balance Roth conversions with funding those buckets.
Nice explanation.
Depending on when you retire, SORR is going to be the highest for the first years of your retirement. I’m planning the highest level of fortification for that first time frame.
Maybe if you come out adequately, and on track, after the first 5-7 years of retirement you can ease your bucket strategy (use fewer years) or go back to an asset allocation strategy?
If you’re refilling your buckets on positive years, aren’t you essentially using all stocks for distributions for that year?
Yes. It’s a bit of mental gymnastics/compartmentalization.
I’ve been using the bucket strategy for 5 years and was pleased to see your positive view of the approach. I’ve been happy with it’s performance from 2018 – 2023 and plan on continuing with the approach.
I’ve documented my use of the strategy in a comprehensive series of articles, thought it would be of interest to anyone interested in seeing more details:
https://www.theretirementmanifesto.com/how-to-build-a-retirement-paycheck/
Thanks for sharing. I don’t know if my view is “positive” or “negative.” I mostly just tried to be descriptive in this piece.
I think it’s one of those things that acknowledges that there is an important behavioral aspect when it comes to personal finance and investing.
I thought the pros/cons you and Karsten did in your two blogs was even better. I have to admit, I find it to be behavioral gymnastics, but for many people that is what they need. I know I have some cash, some bonds and some stocks and I keep them balanced. To be fair, I retired 3 years ago but my pension meets our needs, so I have not dipped into our nest egg. But we have a big trip planned and that will be our first taste of the nest egg.
https://www.theretirementmanifesto.com/is-the-bucket-strategy-a-cheap-gimmick/
I used to listen to The Ray Lucia Show and his “brain trust” on AM radio every week. They were great! Even went to a couple of his presentations and got to meet Ben Stein, one of his guest speakers. These guys were the predecessors to WCI.
I don’t want to rain on anyone’s parade, but nearly all the backtests of bucket strategies that I’ve seen show their performance being no better than a ‘one portfolio’ strategy. Most perform worse.
A minor exception to this is McClung’s Prime Harvesting approach, whereby growth in stocks beyond a pre-determined dollar amount are sold to buy fixed income and withdrawals are only taken from fixed income. Karsten from Early Retirement Now tested this strategy and found that it improved the safe withdrawal rate by .2%. That’s not nothing, but it’s close.
That sounds kind of like Value Averaging.
I agree that I would NOT expect improved performance out of a buckets strategy. At the end of the day, there is an asset allocation there and that is going to determine the performance.
SORR is critical and simplifying your portfolio is probably best for most as usually one spouse runs the show
Firm believer more than ever that the 3 Fund Portfolio is ideal plus cds and munis as a retiree
Although I’ve seen descriptions of the bucket strategy in several places, I haven’t seen what parameters are used to determine when it is a good time to replenish the cash buckets.
Should one replenish when the market is at all time high or within a certain percentage of that?
If one has just started the strategy or just replenished, and the market continues to go up, should one expend from the cash bucket or use the overvalued stocks?
I retired three years ago and I have been using my cash bucket. But, soon, I’ll have to decide whether I start withdrawing from the bond intermediate bucket or recovering stock funds from my longer term bucket.
And I don’t know whether any of those would make much of a difference.
Jim dominating post as always. It seems that you chose the best assets for each bucket in your example of bucket 1 cash, buckets 2 tip as ladder, and bucket 3 equities and real estate. Do you agree your example has the most optimal assets class in each bucket? Do you think maybe research in the bucket strategy may have not outperformed a rebalancing 4% rule strategy given inappropriate Subasset allocation in these buckets? For example, seems a total bond index fund in bucket 2 would seem inappropriate if you needed that money in 3 years given longer duration bonds and equity risk exposure in that index vs your TIPS ladder which is the best way to liability match a safe bucket.
I think a ladder is a better option for money with a definite time period of need.
Nice explanation, Jim. I had a bit of a fuzzy understanding of the bucket strategy, but looking at the varying asset allocations that result with different burn rates makes it easy to understand.
Larry Swedroe reviewed some research on it indicating it underperformed a static asset allocation strategy, mainly because although you are selling high, you never buy low as you do with a static asset allocation. It may have some behavioural benefits – mental accounting etc, but is not optimal.
https://www.advisorperspectives.com/articles/2019/01/07/does-the-bucket-approach-destroy-wealth
I really like your point that asset allocation is less important with this approach. I currently have a typical 60/40 portfolio and I am in my early sixties. I’ve been more conservative in terms of sizing my buckets, as I currently have a bit more than 10 years worth of spending stored in conservative investments (overweight cash right now, given lovely risk-free rates). So, three more years than the typical seven recommended. I plan to retire within a few years, but knowing that I have ten years of funding before needing to sell, I can let riskier investments (equities, REITs) rise as much as they want without rebalancing back to the 60% equities. I just have to adjust for inflation in the ten year bucket, which I would do in good years. Over time, this could lead to your 80/20 or 90/10 allocation without really putting my retirement at risk.
At least, that is my thinking. It took me a while to realize that rebalancing is less important with this approach as long as you keep up with inflation. As you note, this might not lead to the absolute best possible outcome, but it allows me to feel pretty comfortable for the future.
Great article. Thank you.
I have a question on rebalancing. Does this scheme rebalance when the market goes up, or when the market recovers to its old value. For example if the market had the following returns: -10, -10, -10, +11, +11, +11. Do you rebalance at year 4 or at year 6?
Thanks.
That’s the thing about a buckets strategy…you have to decide when and how you’re going to refill the buckets and that’s where the rubber meets the road. I have the same questions you do and I’m not sure anyone knows the answer. You could determine it for the past, but not for the future.
Agreed.
What I like about asset allocation is that it is deterministic. No emotions or market timing is involved.
I feel like bucket strategy leaves some room for emotions and market timing get in the way. Yet, it does feel safer.
I agree.
An alternate approach.
TIPS ladder that each year matures enough cash to cover expenses beyond those provided for by Social Security. This makes for a completely predictable future cash flow. No SORR at all.
Money left after establishing the TIPS ladder can be invested in any way one chooses. In our case, heavily in stocks, with some bonds in case there is an unexpected large expense. The bonds would cover such an expense without having to disturb the TIPS ladder or realize capital gains by selling stock.
With all future expected expenses covered by SS and TIPS and a cushion for unexpected expenses, the remainder can be aggressive with a time horizon some time after our deaths.
The risk, of course, is that changes in laws may eliminate the guaranteed inflation protection of SS or TIPS. In that case, one might have to draw from the portfolio to close the gap between those sources and actual expenses.
Other risk is that projected future expenses could be wrong. If there were some major increase in annual spending, beyond expected, then the rest of the portfolio would have to cover it. Of course, that risk would be there with any spending strategy.
The plan is not to spend down at all. We expect the, conservative, estimated investment returns, plus SS to provide more money than we spend. Hence, net savers through retirement.
I don’t plan to implement a bucket strategy, but appreciate your analysis and think it has merit for some. My question: why not sell part of the Equity bucket during the years Equities climb instead of/in place of blindly withdrawing cash. A climb in Equity value might offset or completely replace the required annual cash flow OR fill part of a subsequent cash bucket year. This sells Equities high AND could eventually buy Equities low, if that’s a choice one makes with extra cash bucket years.
That’s the thing about a bucket strategy. There’s a 1000 different ways you can do it. I have no idea if your idea works well or poorly.
Dr Dahle – great article. Thank you for giving credit to my father. You pretty much nailed it. One thing I would add is that bucket strategies may evolve over time. Adding additional buckets or Shortening/lengthening bucket time horizons and rate of return assumptions as markets and individual risk tolerance change. Also, relating to rebalancing the buckets it’s important to project a targeted value for each bucket and evaluate periodically where you are vs expectations as an additional consideration to adjusting your bucket allocations. Systematically rebalancing across buckets may negate the benefits of bucketing in the long term.
Great article Jim. How would you alter your buckets of money strategy if you had a government pension (say 90K/year)?
I wouldn’t. But that might reduce how much was in each bucket if the need for income was lower.
For example, if you have a $50K pension and you plan to spend $100K a year and have a 2 year cash bucket, you’d have $100K in that bucket. Without the pension, you’d have $200K there.
An insightful article on a complex topic.
It should just be acknowledged for the *less experienced* investors out there, that, much more optimal than any asset reallocation strategy to weather inevitable temporary market downturns are two incredibly powerful tools:
1. The flexibility to lower expenditures whether by downsizing, simplifying, or reducing discretionary spending
And
2. Part time work to produce temporary income through the downturn.
Yes, some can’t utilize one or both of these tools
Yes, some don’t want to utilize one or both of these tools.
But, if you can and are willing to keep these tools in your retirement toolbox, you keep your options open and likely grow your retirement account a lot more in the long run.
Absolutely. Especially flexibility. Highly valuable.
Great article. The only thing I’d maybe add in the initial example (with the retiree with a $4MM next egg and $100K/y in spending) is that, with a spend rate of 2.5% of their portfolio, they would seem to have the ability to tolerate that risk so that higher allocation to stocks actually makes a bit of sense to me. I mean, the dividends alone on that kind of portfolio would cover most of the spending.
I don’t use buckets myself. Instead, I use a more-or-less constant asset allocation where I sell whatever does better in a given year and rebalance each year as needed. I have seen an article from Michael Kitces that basically concluded that this method performs almost identically to the bucket method. However, the one place where the bucket strategy helps me is that it helps me rationalize why my AA is where it is. Knowing that my AA will effectively mean that will generally have a few years of spending in cash or bonds helps me justify keeping it where it is and not tweaking it every time there is a downturn. Hope that makes sense!