It works the other way, simplified version:
- Figure out how much you need, say 40K/yr
- 40K*7 years = $280 in B1. (for simplicity we'll assume inflation rate=CD rate)
- 40K + 7 years of inflation, assume its now 50K/yr
- 50K*8yrs = 400K, but you assume you will have some growth (dividends, etc), the number required today will be less, ie it will grow to 400K, so you may put in 300K into B2 if you think you will conservatively get 33% return over next 8 years
- The rest goes into B3
That's basically it, again you start with how much you need to withdrawal and work from there. I have a spreadsheet that does it but Ray likes to sue anybody who even mentions the word bucket
, so I won't post it.
TJ
Thanks TJ, I have asked multiple times over 3 years how this system works and your the first person to actually provides some numbers. (For you bucket fans, this is money forum and numbers matter!).
So lets set the way back machine to July 1999. The internet is really hot, the unemployment is low, inflation is moderate but there are fears of it rising. People are debating if oral sex is really sex, and Texas governor is looking like the favorite to win the GOP nomination. (See not everything has changed).
B1=280K
(I think historically a 7 year CD ladder probably exceeds inflation by roughly 1% however for those wanting to set up a bucket system today the situation is different. A 7 year CD ladder at Penfed is 1.8% while in inflation is 3.6%. This means that if you were setting up a 40K inflation adjusted bucket 1 today for 7 years you'd need $300K. The good news is with rates so low you really can ignore taxes..)
B2= 275K
Back in 1999, the ten year bill was around 5.5-6.0 for planning purposes I assumed a 5.5% return but I will stick Bucket 2 in the Vanguard Total Bond Market
B3= 445K (1 million - B1 - B2)
I'll stick this in Vanguard Total Stock Market.
Fast forward to July 2006. The economy is doing ok. The stock market is recovering from the 2000 crash. B1 is needs to be refilled,roughly 10K remains due to CD returns exceeding inflation during this time.
As predicted our 275K in bucket 2 has grown to almost exactly 400K, 398 actually. The good news is inflation is slightly lower than predicted we now need $48,400 to keep purchasing power constant. After refilling Bucket 1 with (7 * 48,400) B2 has only 70K left.
Bucket 3 has grown just under 11% and now contains $493K. I guess the main rule with bucket 3 is to not sell at loss. So I can see selling 50K from Bucket 3 to refill bucket 2. However, this only leaves 120K in Bucket 2.
The 10 year T-Bond was yielding 5% back in summer 2006. So in order to refill bucket 1 in 7 years we need to have 340K. However, refilling bucket 2 completely only leave 225K in Bucket 3.
I think this is my main problem with the system. Over 7 years our assets have decreased by 10% and spending needs have increased 20%. I am struggling to understand what the average early retiree is suppose to do in 2006. Refill bucket 2 and leave only a small amount for inflation protection/growth, or short change Bucket 2 and risk running out of money to refill bucket 1 in 7 years? Now with the benefit of 20/20 hindsight it is obvious sell bucket 3 to refill Bucket 2. But how would you know to do this back in Summer 2006.
Now lets move to July 2011. Bucket 3 is up 20% and Bucket 2 is up 100%! Bucket 1 is probably doing better than projected because inflation has been low, you probably have 3 years (150K) left in bucket 1 but the Penfed 6% are a thing of the past 7 year ones are 2.75% today. If you refilled bucket 2 back in 2006 you've done very well total assets near $1.1 million (you are 12 years older and probably able to collect SS now or very soon). If on the other hand you didn't refill bucket 2 your total assets are around 900K, your retirement is still probably ok. However, your buckets seem all screwed up.
So Ray Lucia fans help me fill my buckets.
Bucket 1 is 160K spend rate is 52K/year. 50K in 5% CD due in 2012, 45K in 6% CD in 2013, 40K in a 4% in 2014K, 15K in MM/Checking earning 0%
Bucket 2: 240K total, 50K in Penfed 5% CD in 2021, the rest in Total Bond Market
Bucket 3: 500K total stock market.
What would you do?