3 Bucket Strategy

D

doneat54

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I'm retired, DW is retiring mid 2022. We are very happy with our portfolio positions and have recently worked on (with a FIDO rep, see my thread "Playing FIDO") a retirement expense budget that will go into effect mid 2023 after we sell one of our two homes. We have fattened it up nicely to be able to fund the travel and dining that we value.

But the near term challenge is to fund the ~7 year period after DW retires and before we start drawing SS. Once we are both on SS, it appears to be able to fund 75% of expenses, both essential and discretionary. And yes it is inflation adjusted. I'll spare you the numerical details, but once we get there, i't looks like we will need to pull only 1.5% off the portfolio to supplement SS.

The FIDO guy tried to sell us an annuity to fund that gap, it didn't take long to decide we didn't want that. So I started looking into the 3 bucket approach, with (just my first pass now) bucket one funding years 1-3 years of expenses (including taxes), with an AA of 0/100 and a mix of cash, fixed return investments and bonds. Right now on paper it would be around 12.5% of the portfolio (today's value).

To make the 7 year bridge, I spec'ed the 2nd bucket at 4 years, with a 30/70 AA with the securities probably being in diversified mutuals. 16.7% of today's overall portfolio.

The third bucket I haven't targeted and AA for yet, but I'd probably be happy with something like 70/30 or 80/20.

Having read a bunch of articles on the 3 bucket strategy, the bigger issue is how you balance/re-fill. I have some ideas, but let me leave it at this. Again, the goal is conservatism/immunity for that 7 year bridge, but not missing out on growth opps either. For perspective, our overall portfolio AA today is around 36/64. I had been targeting 30/70 but in need of a balance now. But I see no need to miss out on long term growth in bucket 3 if the first 2 buckets can give me the "pillow test" peace of mind.

Thoughts? Of course things can, and will change long term with regards to our expenses and lifestyle and we'll adjust as needed. But this seems pretty solid to me right now.

I did find this a useful read also:

https://www.forbes.com/sites/robert...is-broken-heres-a-better-way/?sh=7c7864a31b33
 
doneat54 said:
... Thoughts? ...
Click to expand...
A bucket view is a useful way to review a portfolio, especially in situations like yours. An AA view is also useful. There are those who argue that they are the same, but to me it doesn't matter.

Mechanistic rules for buying and selling almost never work except in backtests. IMO managing buckets can be done with a little Kentucky windage; the results won't be perfect but they can be good enough.
 
In addition to what Old Shooter says, those of us blessed with a pension probably take a different perspective. This is especially true for me, because the COLA'd retirement pay allows me to take a much riskier (and in theory more rewarding) approach to any bucket.
 
HawkeyeNFO said:
In addition to what Old Shooter says, those of us blessed with a pension probably take a different perspective. This is especially true for me, because the COLA'd retirement pay allows me to take a much riskier (and in theory more rewarding) approach to any bucket.
Click to expand...


Yes, if we had other income sources, pensions, rents, etc. it might be different. And I realize that at the end of the day, it is all just one big pile and you can spreadsheet it up anyway you like. But the retired engineer in me gets solace in at least mentally being able to break down and know that I don't need night sweats over a market dip.....
 
doneat54 said:
I'm retired, DW is retiring mid 2022. We are very happy with our portfolio positions and have recently worked on (with a FIDO rep, see my thread "Playing FIDO") a retirement expense budget that will go into effect mid 2023 after we sell one of our two homes. We have fattened it up nicely to be able to fund the travel and dining that we value.

But the near term challenge is to fund the ~7 year period after DW retires and before we start drawing SS. Once we are both on SS, it appears to be able to fund 75% of expenses, both essential and discretionary. And yes it is inflation adjusted. I'll spare you the numerical details, but once we get there, i't looks like we will need to pull only 1.5% off the portfolio to supplement SS.

The FIDO guy tried to sell us an annuity to fund that gap, it didn't take long to decide we didn't want that. So I started looking into the 3 bucket approach, with (just my first pass now) bucket one funding years 1-3 years of expenses (including taxes), with an AA of 0/100 and a mix of cash, fixed return investments and bonds. Right now on paper it would be around 12.5% of the portfolio (today's value).

To make the 7 year bridge, I spec'ed the 2nd bucket at 4 years, with a 30/70 AA with the securities probably being in diversified mutuals. 16.7% of today's overall portfolio.

The third bucket I haven't targeted and AA for yet, but I'd probably be happy with something like 70/30 or 80/20.

Having read a bunch of articles on the 3 bucket strategy, the bigger issue is how you balance/re-fill. I have some ideas, but let me leave it at this. Again, the goal is conservatism/immunity for that 7 year bridge, but not missing out on growth opps either. For perspective, our overall portfolio AA today is around 36/64. I had been targeting 30/70 but in need of a balance now. But I see no need to miss out on long term growth in bucket 3 if the first 2 buckets can give me the "pillow test" peace of mind.

Thoughts? Of course things can, and will change long term with regards to our expenses and lifestyle and we'll adjust as needed. But this seems pretty solid to me right now.

I did find this a useful read also:

https://www.forbes.com/sites/robert...is-broken-heres-a-better-way/?sh=7c7864a31b33
Click to expand...


Your approach is a good way to arrive at your portfolio asset allocation.


If you add up your buckets, you'll have approx a 55/45 portfolio. Why not just do that and re-balance each year?


Or each year, you can inch towards your planned post social security asset allocation.
 
walkinwood said:
... If you add up your buckets, you'll have approx a 55/45 portfolio. Why not just do that and re-balance each year? ..
.
Click to expand...
Because the buckets analysis next year might point to some other AA. Not that an AA view is not a good way (also) to view any portfolio, but IMO it should not be a goal to manage a portfolio strictly by looking at AA.

By itself, IMO AA is a crude tool and it will often make sense for AA to vary from year to year. For example, we lived with about a 60/40 AA for quite a while but after a decade or more our personal planning horizon is shorter and our portfolio has grown rather than shrunk, so we went to 75/25. Then, just recently, we began making plans to build a lake home that will eat some cash, so we just sold equities to suit a cash target (aka bucket) and are probably now more like 70/30. I haven't bothered to check because it really doesn't matter much to the plan.
 
walkinwood said:
Your approach is a good way to arrive at your portfolio asset allocation.


If you add up your buckets, you'll have approx a 55/45 portfolio. Why not just do that and re-balance each year?
Click to expand...

+1

Buckets are a form of mental accounting.
 
mrfeh said:
+1

Buckets are a form of mental accounting.
Click to expand...


Wow, thank your for that, and the other poster stating that you are accomplishing the same thing by just managing the overall portfolio AA and keeping things balanced. But you are right, it really is just mental accounting.


Maybe I didn't need to buy that set of 3 buckets after all ??:)
 
doneat54 said:
... it really is just mental accounting. ...
Click to expand...
True enough, but I don't see the point. An AA view is also mental accounting. As is budgeting, as is separating retirement savings from the household budget, as is ... lots of things that we do and find useful.
"Mental accounting (or psychological accounting) attempts to describe the process whereby people code, categorize and evaluate economic outcomes. The concept was first named by Richard Thaler. Mental accounting deals with the budgeting and categorization of expenditures. People budget money into mental accounts for expenses (e.g., saving for a home) or expense categories (e.g., gas money, clothing, utilities).[4] Mental accounts are believed to act as a self-control strategy." https://en.wikipedia.org/wiki/Mental_accounting
​
 
mrfeh said:
+1

Buckets are a form of mental accounting.
Click to expand...

Compartmentalizing investments is quite sensible. If you have different goals with different parts of your money, separating them makes perfect sense.

What OS said.
 
IMO the important thing about the mental accounting concept is that we realize when we are doing it.

The classic Thaler example of a mental acounting error is "house money" where a gambler is willing to take bigger risks with winnings that have put him ahead of the game. That is pernicious mental accounting. Thaler's comment: " ... the fact that some of your money has been made recently should not diminish the sense of loss if that money goes up in smoke."
 
mrfeh said:
+1

Buckets are a form of mental accounting.
Click to expand...


doneat54 said:
Wow, thank your for that, and the other poster stating that you are accomplishing the same thing by just managing the overall portfolio AA and keeping things balanced. But you are right, it really is just mental accounting.


Maybe I didn't need to buy that set of 3 buckets after all ??:)
Click to expand...

Or are they metal accounting? Unless, of course, they are plastic buckets.
:D

In all seriousness, your plan looks fine. As Oldshooter said, just don't be a too hung up on the exact mechanics.

In my case, I look at the buckets similar to AA. Cash and CD's that would cover us for 3-5 years. Bonds, that likely would cover the balance of our needs for life. And stocks that are really there for future inheritance, but are available if the SH!T hit the fan.

For the most part, we are spending bond money, so no need to refill the cash bucket. Is it a drag on returns? Probably. But we are not trying to run up the score, just maintain our current advantage.
 
OP - very solid approach in my opinion. Allocating a different bucket of funds to cover different time periods - near-term, intermediate term and long-term allows you to have different AAs (and hence, different risk) assigned to each.

I have a very similar strategy, although admittedly not as refined or precise. And I definitely haven't worried about re-balancing between buckets. I know we can cover all the years to (hopefully, assuming it's still solvent) SS and Medicare with low-risk assets. I have a different "bucket" for long-term growth, in the SS/Medicare and beyond years.

I personally don't see anything wrong with "bucketizing" and in fact, believe it makes a lot of sense for the reasons mentioned.
 
I don't really care for "buckets" as they seem to be used normally. Bucket #1 is supposed to be for the short term. But if you keep filling it up it just ends up being a long-term fixed income allocation. If you have some algorithmic refill strategy, like emptying it in the first three years and leaving it empty after that, then I can see its use.

If you are going to do some kind of non-static refill scheme between the buckets, like refill bucket #1 when stocks are setting all time highs and use it only during bear markets, then I can see some usefulness.


I use a 75/25 AA for our portfolio. In a bear market, or worse, I reduce the bond allocation in 5% increments. I restore the normal AA when things return to normal and stabilize. So I could be said to have a two bucket portfolio if you would like, and I have rules for filling and emptying that hopefully boost performance a small amount.

We are currently retired and living off only our portfolio for another four years. I started retirement in 2007, and DW worked a few more years. We withdraw 6%-7% of the portfolio per year, but a significant portion of that is discretionary. You can model that situation in FIRECalc (delayed income) without too much trouble. Short periods of heavy portfolio withdrawals are not a total disaster in terms of probability of success. At 75/25 we have about five years of expenses sitting in bonds already, if needed. I have no problem moving to 100/0 if we hit a bear market that lasts five years. If we need even more, I'll sell equities each month as needed and spend a little less. Not the end of the world.

By all means plan for that stretch of no income (good for Roth conversions if that makes sense for you). Maybe you want something conservative for that period. But it should blend into your plans for portfolio withdrawals after the income starts. Something like only bucket 3 remains after all income is in place.

After the income starts there is very little to distinguish between the next three years of withdrawals and any random three years of withdrawals after that. That would seem to call for a fairly stable and long-term AA at that point. I think the argument for special short-term savings disappears at that point, other than handling normal market swings.
 
Don't Worry, Be Happy!!

Bucketing and Budgeting are very useful for folks who need that detail...if it helps them sleep at night, then do it. Whether you have to pay for an expense out of your right pocket or left pocket, you still need to pay for it.

If you have a leaky roof, but you do not have enough funds in your "roof" budget, are you going to wait until you do? If a world cruise is on your bucket list (different kind of bucket), do you wait until you have all the funds saved, do you take out a Home Equity line of credit, or do you do it while you are young enough to enjoy it?

As others have said, money is fungible, and you do not HAVE TO use all of your ENTERTAINMENT dollars for just entertainment. You might want to use some of your intermediate bucket dollars for short term travel when the market has been exceptionally good...and cut back a little bit if the market has not done so great.

Think of your buckets as a planning tool, but do not restrict your life because of those buckets. Give yourself a little bit of flexibility to enjoy your retirement.
 
OP, I think what I would do is to create a CD ladder to fund the 7-year gap.... buy 1,2,3...7-year CDs for the amounts that you need at the beginning of each year and the amturities will provide the money that you need during those years. think of it as building your own 7-year immediate annuity. You indicated that is ~12.5% of your total but consider that to be part of your bond allocation.

So if you want an overall 60/40 AA, you would start with 60% stocks and 40% fixed income (consisting of 27.5% "bonds" and 12.5% CD ladder). Then in subsequent years, rebalance to target as necessary or desired. And after 7 years the CD ladder portion will be gone.

No buckets required.

If you really like the concept though, when you rebalance each year you could add another rung to the CD ladder as part of your rebalancing routine.
 
I find this topic interesting. I may be coming around to the bucket approach, which I've actually done to some extent for the next 6 years while on the ACA. I've got that much in cash, supplementing dividend distributions, but that's mostly to avoid tax surprises.

Overall, I have a single AA for my whole portfolio. I really have no solid idea what it should be. I know to keep some stocks for long term inflation protection, and some cash or bonds to decrease volatility without much impact on return.

Maybe it makes sense to say that the next 6 years should be in very safe investments (like cash), then the next 5 before I take SS should be relatively safe, and after that I'm talking about long term money that could be mostly or all stocks.

Once I'm done with ACA, maybe I want to keep 3 years in very safe money, another 5 in relatively safe, and long term after that.

Gonna mull this over, and play with some AAs for each bucket and see how this comes out.
 
First of all, thanks for all the inputs, this has been really helpful. I can now totally see how the 3 bucket approach is more "mental accounting", but really if I manage the overall portfolio AA, I am achieving the same thing.

I watched the video in that Forbes link that I posted originally, and it made a lot of sense. Check it out if you like and LMK what you think.

While last year, I thought I wanted an overall 30/70 AA, I now think that I realize that might be unnecessarily conservative. With my first two buckets being only 28% of the portfolio to covert the 7 year gap to SS, then I could be as aggressive as an 72/28 AA and still sleep fine at night.



Today our portfolio is around 32/68 AA. If I just let it simmer until DW retires, it will creep upward as the stocks outgrow the bonds/cash. The guy in the Forbes article quotes the founder of the 4% rule as saying that a 50-75% stake in stocks is best for the near, or at retirement portfolio.
 
I also use the Bucket model—for me it’s a conceptual tool—similar to “mental accounting”
I recently described my Bucket approach in the “Hi, I am..” forum.
Some folks are dismissive of this approach but hey, it works for me...and a few others!
Good luck to you...
DD
 
audreyh1 said:
Compartmentalizing investments is quite sensible. If you have different goals with different parts of your money, separating them makes perfect sense.
Click to expand...

+1 Your bucket approach makes perfect sense. Different risk levels, addressed via AA, for different time segments within your retirement, and different income streams coming on at different times.
 
audreyh1 said:
Well you are pretty close to the starting point for the Kitces Rising Equity Glide Path which is a way to handle sequence of return risk (SORR) during early retirement. So you might want to review that.
https://www.kitces.com/blog/should-...is-a-rising-equity-glidepath-actually-better/
Click to expand...


Thanks for the link. It was good re-reading that blog post.


Are you going to implement a rising equity glidepath? IIRC, you're already at a 60-65% equity allocation. If you are, I'm interested in your reasoning.


In the case of the OP, NOT replenishing buckets 1 & 2 will lead to a glide path from 55/45 to 70/30 (approx) in 7 years.
 
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