One of the most important services financial professionals offer their investors may be a well-structured and sustainable retirement income strategy.
Considering the many methods for structuring such a strategy, this process may be overwhelming to retirees and financial professionals alike.
The risks in retirement are different from the risks an investor may have faced while accumulating retirement assets, and often a retiree needs help to thoroughly understand and evaluate these differences. A financial professional’s guidance can be of great help throughout this process.
One approach to developing a retirement income plan is the bucket strategy. A bucket strategy segments retirement assets by certain categories. Categories may be based on the risk level of the assets, the needs or expenses these assets are expected to cover or the period of time in retirement when the assets are expected to generate income. The most widely used bucket strategy is the time-segmentation approach, which is used by almost one-third (28%) of financial professionals, according to the Financial Planning Association.
This approach assigns each bucket to a defined time period in retirement, based upon the retiree’s risk tolerance and time horizon. It anticipates that the allocation will shift over time to traditionally more conservative asset classes as the retirement savings are drawn down.
This article analyzes the potential advantages and shortfalls of the time-segmented bucket strategy, which we refer to here as simply the bucket strategy, by comparing it to the most common strategy in use—systematic withdrawals. The two strategies are compared based on the psychological and economic benefits they can offer a retiree.
While the bucket strategy will have buckets of funds designated for use in specific retirement time periods, there are other attributes that will create differences among particular strategies. Depending on the preference of the investor, the funds may be redistributed among buckets more or less frequently.
Generally, most bucket strategies also have a target for how much cash and short-term investments to keep on hand for current spending needs—the basis for this target may differ by method.
To better understand the bucket strategy, we demonstrate it with an example that utilizes three buckets. When initially established, the first bucket contains cash and cash equivalents and is intended to be utilized and contain sufficient funds to meet spending over the first five years of retirement.
The second bucket is intended to meet spending needs in years 6 to 15 of retirement. It contains mostly fixed-income securities, which are likely to experience greater volatility than cash, but, because they are in the second bucket, the retiree has a longer time period to ride out market swings.
The third bucket contains mostly equities, a traditionally more risky and volatile asset class. It is intended to meet expenses in the years beyond the 15th year of retirement, again providing opportunity to ride out swings with the intention of reaping the potential rewards.