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 withdrawal 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- Money to be withdrawn within 1-2 years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
- What would this money be used for?
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- Money to be withdrawn within 2-5 years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- Money to be withdrawn within 3 years – Leaving your Legacy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