The Bucket Approach To Investing
By Chris Nolt
The bucket approach to investing involves using multiple buckets of money for retirement income. Each bucket contains a different portfolio and each portfolio has a different objective.
There are many different bucket investment approaches. One example of a bucket strategy is to use three buckets, representing portfolios. If the average desired asset allocation for all three buckets is to hold 60 percent in stocks and 40 percent in bonds, the plan would be to invest an amount of money in bucket one which would provide two to four years’ worth of distributions.
I refer to this bucket as the “war chest,” since the objective of this bucket is to provide income when there is a significant market correction. This bucket holds a very conservative portfolio, most likely short-term, high-credit quality bond funds and possibly some cash.
The second bucket, representing the bulk of the money, would be invested in a 60/40 portfolio. Regular distributions for retirement income would be made pro-rata out of each fund within this portfolio in order to maintain the target allocation.
The third bucket would be invested more aggressively, possibly an 80/20 allocation or 100 percent stocks. The objective of this portfolio is to maximize growth.
Distributions would not be made from this bucket for at least five years. Around five years, buckets two and three would be rebalanced to maintain the starting allocation. Or, depending on the situation and the age of the investor, the aggressive bucket might all be moved to a more conservative allocation.
To illustrate this concept, let’s say a 60-year old couple has $1,000,000 to invest for their retirement, and based on their goals and risk tolerance, the chosen asset allocation is 60 percent stocks and 40 percent bonds. They also plan to take $5,000 out of the portfolio each month to live on.
Here is what the plan might look like: Bucket one utilizes $180,000 and is put towards 100 percent conservative bond funds, while bucket two utilizes $550,000 in a 60/40 allocation and bucket three utilizes $270,000 in 100 percent stock funds.
The potential advantages of this type of approach to investing include tax efficiency, enhanced performance and emotional comfort and stability.
Tax efficiency may reduce the amount of gains that must be realized, and enhanced performance may prevent a person from withdrawing money from stock funds during a market decline when stock prices are down.
Additionally, by knowing the investors have a conservatively invested bucket of money to make withdrawals from when the market is down may help a person sleep better at night and prevent them from reacting emotionally and selling stock funds when stock prices are down.
It is worth mentioning when a family has a goal of leaving money to their children, I often advocate having a separate bucket of money for this goal. This portfolio would invest aggressively, since the time frame for the investment is longer and the goal is usually to pass as much money as possible.
It is also important to note since heirs receive a stepped-up basis on the stock and real estate funds at death, their children may not only inherit more money with this approach, but the children may be able to avoid capital gain taxes on this portfolio.
The most important decision with this investment strategy is how the money is invested within each bucket. Owing a globally diversified portfolio of low-cost index funds matched up with the goals and risk tolerance is a prudent approach. For more information on prudent investment strategies, see my other articles on investing or call me to discuss a personalized plan.
Chris Nolt is an independent, fee-only registered investment advisor and the owner of Solid Rock Wealth Management, Inc. and Solid Rock Realty Advisors, LLC, sister companies dedicated to working with families around the country who are selling a farm or ranch and transitioning into retirement. To order a copy of Chris’ new book, “Financial Strategies for Selling a Farm or Ranch,” visit amazon.com or call Chris at 800-517-1031. For more information, visit solidrockproperty.com or solidrockwealth.com.