Aligning Your Investment Portfolio with Your Retirement Timeline
The transition into retirement commonly brings about questions about how one should invest, especially when taking withdrawals for income purposes. This blog explores a strategy commonly known as the “bucket” approach. This strategy aligns different buckets on investments with your retirement timeline, providing liquidity, income and growth potential.
Understanding the Bucket Strategy for Retirement
The bucket strategy involves dividing your investment portfolio into several segments or “buckets,” each with a distinct time horizon and risk level. This approach helps manage risk and liquidity needs by matching investments with the time frame you plan to use them. Understanding your time frame is one of the most important drivers in determining what type of investment is appropriate.
Bucket One: Short-Term Investments
- Prioritizes Liquidity: Bucket one is designed for immediate liquidity. Reasonable investments for this bucket include money market funds, short-term bonds, or other highly liquid assets that provide stability and easy access to funds for the first few years of retirement. This helps avoid the need to sell volatile investments at a loss in a down market.
- Minimal Risk: This bucket holds assets that are low in risk and volatility. It should contain enough funds to cover living expenses for two to three years, complementing other stable income sources like pensions or Social Security.
Bucket Two: Intermediate-Term Investments
- Provides Income and Some Growth Potential: The second bucket focuses on mid-term needs, usually covering the next 4-7 years of retirement. It typically includes income producing assets such as bonds, as well as dividend paying stocks, which also offer some growth potential. Income can be used to refill bucket one as that money is spent.
- Moderate Risk: This bucket will have more risk than your short-term investments but will have less risk than your growth investments in bucket three. Naturally, to target a higher rate of interest and dividend income, you will need to take slightly more risk. You will experience slightly more volatility with these investments, but it should not be excessive.
Bucket Three: Long-Term Investments
- Growth Opportunity: The longest-term bucket in your portfolio is for years 8 and beyond where you can afford to take more risk since you have time to recover any short-term losses. This bucket is intended to provide the highest returns over the long-run, which means it can also have the greatest potential for loss. Investments may include domestic and international stocks as well as real estate. As these investments increase in value over time, they can be trimmed to replenish buckets one and two.
- Highest Risk: In order to aim for higher long-term return, you will have to take more risk with these investments. However, buckets one and two are there to help avoid selling investments at a loss and allow them time to recover.
Balancing Your Portfolio Using the Bucket Strategy:
- Regular Adjustments and Reviews: It’s important to regularly review and rebalance your buckets to adapt to changing market conditions and personal spending needs. This may involve shifting funds between buckets as time passes or as one bucket’s funds deplete. Ideally, growth from bucket three will be used to replenish bucket two and income from bucket two will replenish bucket one.
- Professional Guidance for Tailored Strategies: Working with a financial advisor can help refine the bucket strategy to fit your specific retirement goals and financial situation. They can provide insights into how best to allocate assets in each bucket to maintain an optimal balance of risk and return. While this strategy provides a good framework to follow, there are still a lot of choices to be made about what investments to use and how to manage the strategy on an annual basis.
Beyond Time Horizons: Integrating Tax Efficiency and Legacy Planning:
- Tax Considerations: Each bucket should be optimized for tax efficiency, potentially using tax-deferred accounts for longer-term investments and taxable accounts for funds needed sooner. Depending on your income level, tax-free municipal bonds may make sense as well.
- Incorporating Legacy Goals: Consider how your investment choices in each bucket affect your overall estate plan and legacy goals, ensuring that your longer-term investments align with the financial future you intend to leave to your heirs.
Using the bucket strategy to align your investment strategy with your retirement timeline is a powerful way to manage your assets across different phases of retirement. By clearly defining how to use each portion of your investments based on when you will need them, you can minimize risk and ensure you have a stable financial foundation throughout retirement.