Tag Archives: Drawdown Strategy

Funding Retirement with the Bucket Approach

Have you ever considered separating the money that you plan on drawing down during your retirement based on the phases of your retirement?  A common approach is to allocate different piles of money in separate buckets based on when you plan on using the money.  The Bucket Approach was made popular by Raymond J. Lucia, CFP as the result of his book Buckets of Money.  The theory is based on building a diversified portfolio and spreading the risk out across different buckets of money.

A common approach is to use three buckets, however, more buckets can be used:

Bucket A – Money that will be used for the first few years of retirement (years 2 – 5)

Bucket B – Money that will be used for the second period of retirement (years 3  – 10)

Bucket C – Money that will be used to fund the remaining years of retirement (years 11 – 25 and beyond)

Asset Allocation for Each Bucket

Since Bucket A is going to be the first source of retirement funding, it is suggested that this portion of the asset allocation be ultra conservative.  That is to prevent a major stock market sell-off or recession to deplete the money that will be used to cover the first 2 – 5 years of retirement expenses.  In this bucket, the assets should be invested in CD’s, money market accounts, short-term bonds, or FDIC insured savings accounts.  By always having between 2 – 5 years worth of expenses in liquid assets that are easy to access, it helps from having to sell-off stocks when they have gone down in value.

Bucket B is going to be constructed of a more moderate asset allocation than Bucket A.  This bucket is designed to produce higher returns than Bucket A.  This bucket should have an asset allocation of around 65% in bonds and 35% in stocks.  The bonds are a low-risk investment that provides higher income than short-term holdings.  The stock portion is used to fuel growth and stay ahead of inflation.  The bond allocation could be made up of both an intermediate-term bond fund and a TIPS fund.  A large-cap index fund or large-cap dividend fund are good options for the stock portion of Bucket B.

Bucket C is going to have a more aggressive asset allocation than Bucket A and B.  This bucket of money will be used for long-term growth.  It will be made up of an asset allocation of 75% in stocks and 25% in bonds.  By keeping a portion in bonds, an investor can rebalance annually.  This practice of buying low and selling high improves the long-term performance and reduces the risk of this asset allocation.  For the bond allocation, a total bond market fund is a good option.  For the stock allocation, a more diversified mix of large-cap, small-cap, and international stock funds are used in this portion of the bucket for aggressive growth.

Refilling the Buckets

With a more traditional approach to asset allocation, a portfolio is viewed as a whole and not fragmented into different categories based on when the money will be needed.  For example, a balanced portfolio might be made up of 40% in bonds and 60% in stocks.  If stocks have a good year and the new asset allocation is 65% stocks and 35% bonds, the investor simply sells the stocks high and rebalances back to the desired asset allocation.

With the bucket approach, there is rebalancing within each bucket as well as replenishing between buckets.  Bucket A has 2- 5 years worth of living expenses.  When Bucket A has 1 years worth of living expenses drawn down, the difference will be replenished from Bucket B.  The same process applies between Bucket B and Bucket C.  When money is moved from Bucket B to Bucket A, Bucket B must be replenished from Bucket C.

Buckets vs Systematic Drawdown

Some financial advisors favor the buckets approach for the psychological benefits it provides investors.  When an investor is faced with a major market decline, they feel more confident because they know they have 5 years of living expenses in cash.  That financial cushion helps to prevent investors from selling stocks when they are at or near the bottom of a market.  Bucket A provides a level of comfort during good times and bad.

Other financial advisors prefer a systematic drawdown approach.  It is viewed as an easy approach for investors to understand and apply.  They feel that it is less complicated for an investor to view their portfolio as a whole and to use a safe withdrawal rate of 3 – 4% from a conservative portfolio of 50% in stocks and 50% in fixed assets.

There are more similarities between these two approaches than there are differences.  Even though there are three different asset allocations, in the three different buckets, when they are added together, they still can simply add up to the same mix of 50% in stocks and 50% bonds in the portfolio that is applied in a systematic drawdown approach.  It is just a different way of mentally accounting for assets during retirement.

Implementing the Buckets Approach

The buckets approach should be considered by people who are planning on retiring early.  Many people save up substantial resources in their 401K, but cannot access their money until age 60.  The buckets approach can be an alternative to a Roth conversion.  This approach just has to be planned years in advance because it requires an investor to build up substantial savings in their taxable account along with their tax-deferred accounts.

For this example, let’s assume that a person wants to retire at age 50, requires $50,000 per year for living expenses, and has $500,000 of their $1.5 million-dollar portfolio in taxable savings.  This scenario would be ideal for the buckets approach:

Bucket A – $250,000 in taxable savings (age 50-55)

Bucket B – $250,000 in a taxable account (tax-free bonds, age 56-60), the remaining mix of assets in an IRA or 401K to be drawn down after age 60

Bucket C – All in an IRA or 401K

Conclusion

The buckets approach is slightly more complex than a systematic drawdown strategy.  The main benefit is that it helps to keep the mind of the investor more at ease during all market conditions.  If managed correctly, the theory is that an investor will always feel secure because they always have 2 – 5 years of cash to fund the next few years of expenses.

The buckets approach is customizable to your unique situation.  The three buckets approach is the most common strategy.  It is the most ideal for a retiree who has at least 25 years of living expenses in savings.

More buckets can be added.  For example, if you have more than 25 years worth of projected living expenses in savings, you can add more buckets to extend your savings further out into the future. You also must take into consideration if you have a taxable account, a 401K with RMD’s (Required Minimum Distributions) at age 70, a Roth IRA account that does not require RMD’s, and Health Savings Account (HSA) to cover future medical bills.

If you are looking at establishing a conservative drawdown strategy, a buckets approach is worth considering.  It requires a little more work than a standard systematic strategy.  However, if you enjoy the mental accounting, the extra work might add to your peace of mind.  Just as when you were working towards building your wealth, the best plan is the one that you can follow.

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Early Retirement Portfolio & Plan

Thank you for reading part-4 in my series on asset allocation.  In my last post, I wrote about our current balanced-growth asset allocation.  That is the asset allocation that we plan on maintaining until we retire in 2028.

In this post, I will be considering the future.  This post is about how I foresee our assets being allocated at the time of retirement.  I use the word foresee because it is what I am anticipating.  As I stated in my previous post, I don’t have a crystal ball.  Nobody can predict the future, but this is what I am optimistically forecasting.

At the time of retirement, I will be age 52 and my wife will be age 60.  At age 60, my wife will draw a Pension equal to 70% of her last annual salary.  The Pension technically has a cost of living adjustment (COLA), but there has not been an adjustment in over 15 years.  Moving forward, we are not going to count on any COLA adjustments.

By 2028, we plan on having about 50 years of annual living expenses in investable assets.  To come up with that amount, I have run our figures on many different financial calculators including AARP, Charles Schwab, and Fidelity that take the future projected growth of different asset allocations into account.  The 50 years of living expenses are based on what we currently have saved, the amount we plan on adding to our savings, as well as projected market performance.

The asset allocation that we plan on using at retirement will be 50% invested in stocks and 50% invested in bonds/cash:

S&P 500 Index Fund – 32%

Extended Market Index Fund – 8%

Total International Stock Market Index Fund – 10%

Intermediate-Term Bond Fund – 32%

TIPS Fund – 10

Cash – 8%

At retirement, we are planning on withdrawing only 1.8% per year from our portfolio.  Based on the Vanguard Monte Carlo Nest Egg Calculator, our success rate is projected to be 100%.  We also have a greater than 100% projected success rate on Firecalc.com and the Trinity study.

Between the pension and withdrawing 1.8% from our portfolio, we will have $112K per year to live on.  Just based on simple math, if we are taxed at 25%, we would have $7K per month to live on.  That would be more than double of what we live on now with fewer expenses.

For the first 10 years of retirement, we plan on withdrawing from our taxable account.  When my wife is age 70, we will be forced to withdraw from her Traditional IRA because of Required Minimum Distributions (RMD).  At that point, we will still be 8 years away from having to withdraw from my Traditional IRA.  We might never have to touch our Roth IRA accounts.  If we do use our Roth IRA accounts, it might just be to withdraw extra money without causing us to go into a higher tax bracket.

We are currently planning on being flexible when it comes to Social Security.  Our goal is to take it when my wife is 70 and I am 62.  We are, however, keeping the option open to taking it early based on retiring during a prolonged market correction. Otherwise, the amount that we will collect will compound 7% annually for every year my wife waits between age 62 and 70.

For some people, this plan might seem too conservative.  For me, being a little on the conservative side is important.  That is because I am retiring at a young age.  I have to plan on being able to fund a retirement of at least 35 years for both my wife and myself.

For me, I don’t see it as being overly conservative.  I see it more as being flexible.  By only planning on a 1.8% withdrawal rate, we have a great amount of flexibility.  If we had to increase it to 2.8%, our success rate only falls to 98% on the Vanguard Monte Carlo Nest Egg Calculator.  If my wife had to work two more additional years, her pension would jump to 80% of her last annual salary.  Also, I will most likely still work part-time because I want to continue to take advantage of my catch-up contributions in my retirement accounts.

That is how our future plan looks.  It is over 11 years from now.  I don’t want to get too excited.  Between now and then, we will work hard, save, invest, take care of our health, and enjoy every day.

Also, please check out the following links from some of the top personal finance blogs to learn about the #DrawdownStrategy Chain:

Anchor: Physician On Fire: Our Drawdown Plan in Early Retirement

Link 1: The Retirement Manifesto: Our Retirement Investment Drawdown Strategy

Link 2: OthalaFehu: Retirement Master Plan

Link 3: Plan.Invest.Escape: Drawdown vs. Wealth Preservation in Early Retirement

Link 4: Freedom is Groovy: The Groovy Drawdown Strategy

Link 5: The Green Swan: The Nastiest, Hardest Problem in Finance

Link 6: My Curiosity Lab: Show Me The Money: My Retirement Drawdown Plan

Link 7: Cracking Retirement: Our Drawdown Strategy

Link 8: The Financial Journeyman: Early Retirement Portfolio & Plan

Link 9: Retire by 40: Our Unusual Early Retirement Withdrawal Strategy

Link 10: Early Retirement Now: The ERN Family Early Retirement Captial Preservation Plan

Link 11: 39 Months: Mr. 39 Months Drawdown Plan

Link 12: 7 Circles: Drawdown Strategy – Joining The Chain Gang

Link 13: Retirement Starts Today: What’s Your Retirement Withdrawal Strategy?

Link 14: Ms. Liz Money Matters: How I’ll Fund My Retirement

Link 15: Penny & Rich: Rich’s Retirement Plan

Link 16: Atypical Life: Our Retirement Drawdown Strategy

Link 17: New Retirement: 5 Steps for Defining your Retirement Drawdown Strategy

Link 18: Maximize Your Money: Practical Retirement Withdrawal Strategies Are Important

Link 19:  ChooseFI:  The Retirement Manifesto – Drawdown Strategy Podcast

Please remember to check with a financial professional before you ever buy an investment and to read my Disclaimer page.