One approach to planning your retirement income that has gained traction for its simplicity and effectiveness is the 3-bucket strategy. Also known as the 3-bucket rule or the three buckets of money approach, the objective of the bucket retirement strategy is to balance income, growth, and security by dividing your assets into short-term, medium-term, and long-term buckets.
In this article, we’ll explore this retirement income drawdown strategy, its pros and cons, the timelines involved, and how to set up a 3-bucket strategy to secure your financial future.
But the 3-bucket strategy is not for everyone. Working with a financial advisor from ARQ Wealth can help ensure your strategy is tailored to your unique circumstances.
If you would like personalized guidance, call ARQ Wealth at (480) 214-9572 or use our contact form to schedule a free consultation.
What Is the 3-Bucket Retirement Strategy?
The retirement bucket strategy is a straightforward approach to retirement portfolio planning for generating income to meet cash flow needs while maintaining a diversified investment portfolio of stocks and bonds.
The concept simplifies retirement income planning by compartmentalizing current and future income into the three buckets (portfolios), each with a specific time horizon and an asset allocation designed for a specific objective.
For example, the first bucket is filled with cash and cash equivalents for meeting current expenses and emergencies. The second bucket might be invested in short- to intermediate-term bonds to allow for the generation of a higher return. The third bucket is your growth portfolio allocated among stocks and bonds for growing your lifetime income value.
The 3-bucket approach can be less overwhelming than managing a single large portfolio, especially during turbulent times. For example, if you had retired in 2008 utilizing the four percent rule, you would have taken systematic withdrawals from one portfolio during a down market, risking early depletion of your retirement assets.
However, with the bucket approach, your cash needs for the first few years are already set aside, so you wouldn’t need to sell stocks at the worst possible time. The bucket containing a stock and bond portfolio is earmarked for income 10 or more years out, giving it plenty of time to roll through the market cycles.
This retirement bucket strategy is designed to provide a clear roadmap for managing risk, ensuring liquidity, and fostering long-term growth. The approach is flexible, allowing you to adjust the buckets based on your retirement timeline, financial goals, and risk tolerance.
How the 3-Bucket Strategy Works
The 3-bucket rule operates on the principle of time-segmentation, matching your investments to your financial needs over different phases of retirement. Here’s how each bucket functions:
Short-Term Bucket (1 to 3 years)
This bucket is filled with highly liquid, low-risk assets like cash, money market accounts, or short-term Treasury bonds. The goal is to cover immediate expenses, such as housing, groceries, healthcare, or travel, without exposing your funds to market volatility.
For example, if you estimate needing $50,000 per year for living expenses, you might keep $100,000–$150,000 in this bucket to cover 2–3 years.
Medium-Term Bucket (4 to 10 years)
This bucket bridges the gap between immediate needs and long-term growth. It typically includes investments like bonds, fixed annuities, or dividend-paying stocks, which offer a mix of income and moderate growth. These assets are less volatile than equities but provide better returns than cash.
The funds here replenish the short-term bucket as it depletes, ensuring a steady cash flow over the next 4–10 years.
Long-Term Bucket (10+ years)
The final bucket is for the later stages of retirement, often 20–30 years or more.
It focuses on growth to ensure your portfolio lasts as long as you do, accounting for rising costs due to inflation or healthcare needs. It’s invested in growth-oriented assets, such as stocks and mutual funds.
Since these funds won’t be touched for a decade or more, they can withstand market fluctuations, allowing for higher potential returns.
Over time, this bucket refills the medium-term bucket, creating a sustainable cycle.
The bucket retirement strategy involves periodically rebalancing and transferring funds between buckets. As you spend from the short-term bucket, you replenish it from the medium-term bucket, which, in turn, is refilled from the long-term bucket during favorable market conditions.
With this approach, you minimize the need to sell assets at a loss during market downturns.
The timelines are flexible and can be adjusted based on your retirement age, life expectancy, and financial goals. For instance, a younger retiree might extend the medium-term bucket to 15 years, while an older retiree might shorten it to 5 years.
Pros of the 3-Bucket Strategy
The 3-bucket strategy offers several advantages for retirees seeking a structured, flexible approach to managing their finances:
Risk Management: With a diversified portfolio across different time horizons and asset types, the strategy minimizes the effect of market volatility. The short-term bucket protects your immediate needs, while the long-term bucket allows for growth without risking short-term stability.
Liquidity and Accessibility: The short-term bucket ensures that your cash is readily available for emergencies or planned expenses, reducing the need to liquidate investments at inopportune times.
Inflation Protection: The long-term bucket’s focus on growth-oriented investments helps your portfolio keep pace with inflation, preserving your purchasing power over decades.
Psychological Comfort: The clear separation of funds into 3 buckets of money provides peace of mind, as retirees can see exactly where their income will come from in the short, medium, and long term.
Flexibility: The strategy is customizable, allowing you to adjust bucket sizes, investment choices, and timelines based on your unique needs, income sources (e.g., Social Security or pensions), and risk tolerance.
Cons of the 3-Bucket Strategy
While the three bucket strategy is effective for many, it’s not without drawbacks. Consider these potential challenges:
Complexity in Management: Maintaining three separate buckets demands ongoing oversight and regular rebalancing. You need to determine when and how to move funds between buckets, which can be time-consuming and might require financial expertise.
No Guaranteed Returns: While the strategy’s objective is to balance risk, there’s no guarantee that investments in the medium- or long-term buckets will perform as expected. Market downturns could impact your ability to replenish buckets.
Opportunity Costs: Holding a significant portion of your portfolio in low-yield, short-term assets may limit overall returns, particularly when interest rates are low or inflation is high.
Requires Discipline: The bucket retirement strategy relies on disciplined spending and rebalancing. Overspending from the short-term bucket or failing to adjust investments could disrupt the plan. Not One-Size-Fits-All: The strategy may not suit everyone, particularly those with limited savings or those who prefer a simpler approach, like a single diversified portfolio.
How to Set Up a 3-Bucket Retirement Strategy
Setting up a retirement bucket strategy requires careful planning and consideration of your current and future financial needs. Here’s a step-by-step guide:
Assess your retirement needs
Calculate your annual expenses, including essentials (housing, healthcare) and discretionary spending (travel, hobbies). Factor in income sources like Social Security, pensions, or part-time work to determine how much you’ll need from your savings.
Determine bucket sizes
Estimate how much to allocate to each bucket based on your timelines and expenses. For example, if you need $50,000 per year, you might allocate $150,000 to the short-term bucket (3 years), $350,000 to the medium-term bucket (7 years), and the remainder to the long-term bucket.
Choose investments
Short-Term Bucket: Invest in cash, money market funds, certificates of deposit (CDs), or short-term Treasury bonds. These assets prioritize safety and liquidity.
Medium-Term Bucket: Consider intermediate-term bonds, bond ladders, fixed annuities, or conservative dividend stocks for income and moderate growth.
Long-Term Bucket: Allocate to growth stocks, index funds, ETFs, or longer maturity bonds for long-term growth. Diversify to manage risk.
Set up separate accounts for each category to keep things clear and make management easier. For instance, use a high-yield savings account for the short-term bucket, a brokerage account for the medium-term bucket, and a retirement account (such as an IRA) for the long-term bucket.
Rebalance regularly: Monitor your buckets and rebalance as needed. When the short-term bucket runs low, replenish it from the medium-term bucket. Similarly, refill the medium-term bucket from the long-term bucket during periods of market growth to avoid selling at a loss.
Consult a Financial Advisor
A professional can help you customize the 3-bucket strategy, select appropriate investments, and adjust for tax implications, inflation, and changing market conditions. They can also ensure your plan aligns with your risk tolerance and retirement goals.
Why Consult a Financial Advisor?
While the retirement bucket strategy is a powerful framework, its success depends on proper execution and ongoing management. A financial advisor can provide invaluable expertise, helping you:
- Tailor the strategy to your specific financial situation and goals.
- Navigate complex investment options and tax considerations.
- Adjust your plan as market conditions, expenses, or personal circumstances change.
- Avoid common pitfalls, such as over-allocating to one bucket or mismanaging withdrawals.
Though the strategy offers clear benefits, it demands careful planning and discipline for effective execution. Consulting a financial advisor is a wise move to tailor the approach and protect your financial future.
Learn more about implementing your ideal retirement strategy by scheduling a no-obligation consultation with an ARQ Wealth advisor. They can provide personalized insights and help ensure your retirement plan is built to last. Start planning today for a confident, worry-free retirement.