If you are currently, or up to 3-5 years away from, withdrawing your retirement savings, the time-based bucket theory may be a good fit for you. As you shift from wealth accumulation to wealth distribution, you need a strategic plan to match spending needs with assets in your investment portfolios. One solution we advocate is known as the Bucket Theory.
What is the Time-Based Bucket Theory?
Simply put, this is a methodology that considers when you will need to withdraw money from your investment accounts. This strategy helps protect you by working like dollar-cost-averaging but in the reverse. For example, if you needed $50,000 and withdrew it all from your IRA which was invested in several different stocks, you may now have been forced to sell at the current market price after a market correction and possibly lose money. With this strategy, you would have the $50,000 already in a bucket that was invested in a liquid asset allocated separately from risky assets.
Here’s how it works:
Bucket #1 - Short-term spending needs
- Money to be withdrawn within 1-2 years
- What would this money be used for?
- Car, taxes, education, vacation, current charitable giving
- Unknown “wants” reserve…get away weekend to Chicago. $425 Cubs tickets
- Income statement shortfalls
- How would this money be invested?
- Money market funds, bank accounts, CD’s with 1-year or less maturities
- Why would it be invested this way?
- For easy access or liquidity with little or no cost to you
Bucket #2 - Medium- term spending needs
- Money to be withdrawn within 2-5 years
- What would this money be used for?
- Known needs: car, taxes, education, upcoming family vacation, charitable pledges
- Income statement shortfalls
- Unknown “wants” reserves (i.e. a month in London)
- How would this money be invested?
- Money market funds, bank accounts, CD’s with 2-3-year maturities
- Bond ladders
- Why would it be invested this way?
- It focuses on maturities of 2-3 years to be ready upon withdrawal at that time at a very low cost to you.
- What would this money be used for?
Bucket #3 - Longer- term investment assets
- Money to be withdrawn within 3 years – Leaving your Legacy
- What would this money be used for?
- Known needs: car, taxes, education, upcoming family vacation, charitable pledges and endowments
- Income statement shortfalls
- Family legacy: leave each child/grandchild substantial resources
- How would this money be invested?
- Money market funds, bank accounts, CD’s with longer-term maturities
- Bonds, bond funds, bond ladders, real estate, third-party managers
- Stocks, stock funds, third-party managers
- Business interests, venture capital
- Why would it be invested this way?
- With a longer time-frame, this money doesn’t have to be as liquid and can be risky according to your risk tolerance to also keep up with inflation
- What would this money be used for?
Take Steps to Protect Yourself
Talk to your advisor about whether or not you’re currently using a bucket theory. You need to match your goals and time frame to the buckets. Some other tips to help you while you’re in retirement:
- Replenishment of buckets 1 & 2
- As cash depletes, put in more. Makes sense!
- Review wants and needs at least annually
- Have your advisor evaluate your tax situation to be efficient when rebalancing
Dollar cost averaging will not guarantee a profit or protect you from loss, but may reduce your average cost per share in a fluctuating market.
Rebalancing may be a taxable event. Before you take any specific action be sure to consult with your tax professional.
All investing involves risk, including the possible loss of principal. There is no assurance that any investment strategy will be successful.