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Buckets of Money: A Retirement Income Strategy

Some retirees are able to live solely on the earnings that their investment portfolios produce, but most also have to figure out how to draw down their principal over time. Even if you've calculated how much you can withdraw from your savings each year, market volatility can present a special challenge when you know you'll need that nest egg to supply income for many years to come.

When you were saving for retirement, you may have pursued an asset allocation strategy that balanced your needs for growth, income, and safety. You can take a similar multi-pronged approach to turning your nest egg into ongoing income. One way to do this is sometimes called the "bucket" strategy. This involves creating multiple pools of money; each pool, or "bucket," is invested depending on when you'll need the money, and may have its own asset allocation.

Buckets for your "bucket list"

When you're retired, your top priority is to make sure you have enough money to pay your bills, including a few unexpected expenses. That's money you need to be able to access easily and reliably, without worrying about whether the money will be there when you need it. Estimate your expenses over the next one to five years and set aside that total amount as your first "bucket." Safety is your priority for this money, so it would generally be invested in extremely conservative investments, such as bank certificates of deposit, Treasury bills, a money market fund, or maybe even a short-term bond fund. You won't earn much if any income on this money, but you're unlikely to suffer much loss, either, and earnings aren't the purpose of your first bucket. Your circumstances will determine the investment mix and the number of years it's designed to supply; for example, some people prefer to set aside only two or three years of living expenses.

This bucket can give you some peace of mind during periods of market volatility, since it might help reduce the need to sell investments at an inopportune time. However, remember that unlike a bank account or Treasury bill, a money market fund is neither insured nor guaranteed by the Federal Deposit Insurance Corp.; a money market attempts to maintain a stable $1 per share price, but there is no guarantee it will always do so. And though a short-term bond fund's value is relatively stable compared to many other funds, it may still fluctuate.

Refilling the bucket

As this first bucket is depleted over time, it must be replenished. This is the purpose of your second bucket, which is designed to produce income that can replace what you take from the first. This bucket has a longer time horizon than your first bucket, which may allow you to take on somewhat more risk in pursuing the potential for higher returns. With interest rates at historic lows, you might need some combination of fixed-income investments, such as intermediate-term bonds or an income annuity, and other instruments that also offer income potential, such as dividend-paying stocks.

With your first bucket, the damage inflation can do is limited, since your time frame is fairly short. However, your second bucket must take inflation into account. It has to be able to replace the money you take out of your first bucket, plus cover any cost increases caused by inflation. To do that, you may need to take on somewhat more risk. The value of this bucket is likely to fluctuate more than that of the first bucket, but since it has a longer time horizon, you may have more flexibility to adjust to any market surprises.

Going back to the well

The primary function of your third bucket is to provide long-term growth that will enable you to keep refilling the first two. The longer you expect to live, the more you need to think about inflation; without a growth component in your portfolio, you may be shortening your nest egg's life span. To fight the long-term effects of inflation, you'll need investments that may see price swings but that offer the most potential to increase the value of your overall portfolio. You'll want this money to grow enough to not only combat inflation but also to increase your portfolio's chances of lasting as long as you need it to. And if you hope to leave an estate for your heirs, this bucket could help you provide it.

How many buckets do I need?

This is only one example of a bucket strategy. You might prefer to have only two buckets--one for living expenses, the other to replenish it--or other buckets to address specific goals. Can you accomplish the same results without designating buckets? Probably. But a bucket approach helps clarify the various needs that your retirement portfolio must fill, and how various specific investments can address them.

Note:   Before investing in a mutual fund, carefully consider its investment objectives, risks, fees, and expenses, which can be found in the prospectus available from the fund. Read it carefully before investing.