This "bucket approach" is an investment strategy for retirement that aims to shelter retirees’ portfolios from the risk of a stock market crash. This strategy follows the idea of splitting a portfolio into clearly-defined buckets, with each going to work on something different.
Amy Arnott, a portfolio strategist with Morningstar Research Services, urges use of the so-called “bucket approach” to avoid dangers encountered in retirement. The strategy’s goal, then, is to deliver both fixed income certainty and market volatility assurance.
The “bucket approach” splits a retirement portfolio into three main segments. The first bucket focuses on liquidity, maintaining one to two years’ living expenses in cash. This allocation is important because it provides quick access to cash for day-to-day operating costs. The second bucket is all about the money. It consists of short- to intermediate-term bond or bond fund investments that allow for the purchase of regular, reliable income. The third bucket is really to implement growth, a mix of stocks to increase long-term value in the portfolio.
The most compelling benefit of the “bucket approach” is that it dramatically lowers sequence risk. This is particularly advantageous in the first few years of retirement. Sequence risk is the risk that having negative returns in the first few years of retirement greatly reduces the chances a portfolio will last.
It does take some maintenance from year to year. - Arnott
This is perhaps the biggest factor in reducing and/or avoiding sequence risk altogether. According to research, a portfolio with 60% stocks and 40% bonds demonstrates lower sequence risk compared to portfolios with higher stock allocations.
In reality, the first five years of retirement are the most dangerous. Withdrawing funds in the midst of a market downturn can have catastrophic results. So, for example, let’s say Arnott’s portfolio suffers a 15% downturn in the first year of retirement. If he withdraws 3.3% too, it will fail pretty miserably.
The Morningstar research also assumed future annual withdrawals were constant as a percentage of the portfolio. This nature of market volatility makes this approach an imperative to plan with intention and remain flexible with withdrawal strategies.
