The Bucket Strategy is Helping Retirees Limit Their Losses and Keep their Cash Flowing in 2022

With the recent arrival of a bear market, the newly retired are facing a sobering reality: having to sell investments during a downturn to meet their income needs. This nightmare scenario, known as sequence risk, can shorten the lifespan of a retirement portfolio and send retirees scrambling for additional income.

A financial advisor can help you plan for retirement and navigate market volatility. Find a trusted fiduciary advisor today. 

Then again, retirees who use the bucket strategy for investing and withdrawing their assets may be better insulated from the recent turmoil on Wall Street. The bucket strategy relies on segmenting your sources of income into different groups or “buckets,” each with a set time horizon and corresponding risk level. It aims to provide retirees with enough cash to cover several years’ worth of expenses without having to tap their investments during a down market.

Christine Benz, director of personal finance for Morningstar, recently examined the performance of several model portfolios that employ the bucket strategy. While these model portfolios have all lost money in 2022, they’ve performed better than the traditional 60/40 portfolio, an asset allocation commonly used by retirees. They’ve also outperformed the S&P 500, which was down 21% through the first six months of the year, by a wide margin.

“[T]he Bucket system has delivered by keeping the faucets open,” Benz wrote. “Retirees using a Bucket system can draw upon their cash reserves without having to disrupt their long-term investments, which have likely experienced price declines so far this year.”

Retirement Bucket Strategy Explained

The bucket strategy is a system for spreading your assets across different groups of investments that will be tapped at various points. The approach typically calls for three different buckets of assets, each with varying levels of risk.

Your short-term bucket will hold enough cash and cash equivalents to cover approximately two years’ worth of spending needs. This cash bucket, which is largely unaffected by market fluctuations, is designed to insulate you from sequence risk and help you avoid withdrawing riskier assets during a down market.

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The intermediate bucket will comprise investments that you plan to tap and convert into cash three-to-10 years in the future. This bucket may include longer-maturity bonds, preferred stocks, growth and income funds and other fixed income assets. Finally, a long-term bucket will hold equities and riskier investments that you plan to hold for at least 10 years.

In theory, the bucket system enables retirees to use their cash cushion to meet short-term spending needs, all while riding out market volatility and avoiding withdrawals during a downturn.

How The Bucket Strategy Has Performed in 2022

Benz tracks the performance of six different model portfolios that employ the bucket strategy: three that use mutual funds and three that use exchange-traded funds.

All six model portfolios range in risk level, going from aggressive to moderate to conservative. Her equity-heavy aggressive portfolios, which include an 8% cash bucket, have unsurprisingly faired the worst this year and are down approximately 12%. The moderate and conservative portfolios, which include cash buckets of 10% and 12%, respectively, have performed better. While the moderate portfolios were down approximately 10% in late June, the conservative options had lost just 8% in the same time.

No, retirees aren’t making money using the bucket strategy. However, they are meeting their income needs while doing minimal damage to the long-term viability of their portfolios.

How to Refill Your Cash Bucket

Of course, one caveat of the bucket strategy is the need to replenish the short-term cash bucket after its been exhausted. This likely won’t be a problem if the markets rebound within two years (or how ever long the cash bucket is designed to last).

But what if stocks and bonds don’t bounce back within two years, and a more protracted bear market sets in? Benz says the answer lies in finding the “least bad option,” likely short-term bonds. Start by selling these, Benz suggests.

“They’re not a cash substitute, but over market history, their losing periods have tended to be both shallow and short-lived,” she said.

While retirees may also look to nonportfolio solutions for generating income, like an annuity, they may not have the capital to purchase one. A reverse mortgage or cashing out a life insurance policy are two other routes a retiree could consider in such a scenario.

Bottom Line

The bucket strategy is a system for investing and withdrawing assets to meet short-term spending needs while avoiding sequence risk. It involves segregating assets into different “buckets,” each with a defined time horizon and risk level. Morningstar’s Christine Benz recently reviewed the performance of several model portfolios that use the bucket strategy and found that while these asset allocations have lost money in 2022, they’ve outperformed the traditional 60/40 portfolio.

Retirement Planning Tips

• A financial advisor can help you through the all-important process of retirement planning, give you investment advice and even help with your estate planning. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.

• Whether retirement is just around the corner or still decades away, knowing where you stand is a critical part of any retirement plan. SmartAsset’s Retirement Calculator can help you estimate how much you can except to have saved by the time you’re ready to retire.

• For retirees who are more focused on limiting their tax bills, Fidelity found that proportionally withdrawing assets from different buckets simultaneously can result in a lower tax liability compared to the traditional bucket strategy.

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