The 2+ Bucket Strategy Explained for Secure Retirement

There is psychological security with these for clients. If they can look at a bucket and say, I know that bucket is going to fund my lifestyle, especially since I have that emergency fund, for the next three years.

It's usually the minimum when you're doing something like this, but five is a common one or even seven, in some cases longer. I have comfort in that. That sleep at night factor is incredibly powerful, especially for those that are entering retirement. Welcome to the Healthy and Wealthy Retirement, where your certified retirement counselor, Mark Struthers, takes a holistic approach to retirement.

Going beyond finances and embracing holistic well-being, this YouTube channel will address not just the financial part of retirement, but also the social, the physical, and the emotional part of retirement. of retirement. Everything you need for healthier, a wealthier, and a happier retirement. Welcome to the Healthy and Wealthy Retirement. My name is Mark Struthers, and I appreciate you joining us. I never take for granted the trust that clients or even listeners or watchers

give us as we try to help you have a healthier and wealthier retirement. to that end. We are talking about a bucket strategy. You hear bucket strategies all the time. We've covered some of the more common ones here. And with retirement planning, it is tougher and it's much tougher than it used to be. You're dealing with this complex puzzle. One, our financial lives are probably a lot more complex than they should be. But you have all these competing factors.

And when it comes down to it, for most people, Well, it's about producing income. How do you replace the income that you're giving up in retirement? And I often like to talk about things that have kind of come up recently. So if I get several questions or clients or conversations at conferences or speaking engagements, I will often talk about them here.

And one of them that's come up recently is it's called the two, I'm going to call the two pluss. 2.5, 2.2, bucket strategy. And the reason I'm talking about this one, even though we've talked about other bucket strategies, is that this one has a focus on income. So we're going to break down what I often hear about this particular bucket strategy, give you some pros and cons, and you decide whether or not it is right for you.

First off, with any of these strategies, I think having some kind of separate emergency fund. I'm a big fan of emergency funds, whether you're in the accumulation phase in your 20s, 30s, 40s, 50s, even in the 60s, or in retirement as well. So that's what I call the plus, whether it's 2.2 or just plus 2.5. But having something that is there as a cushion, even if you are planning risk and return and distribution strategies and everything really, really well.

We're dealing at guessing, making an educated guess. And some of us take a lot of pride in that we're making most educated, best guess we can, but we're still guessing at the future. So having that emergency fund. Because you're not working, it's not an income replacement emergency fund like in the accumulation phase. But think in terms of unexpected medical costs. Especially what if you are on, say, an exchange, an ACA exchange, health care plan, Affordable Care Act, like here in Minnesota.

What if the cost or credits or the terms of those change? And you see it with different administrations, it's possible. What if Medicare covers less and less? Or think about a large home repair or a family emergency, say a child moves back home or just needs help. So having something that can fill that void and have some comfort. Now, having that comfort, usually there's a cost with that comfort, meaning yield return.

That cost has been low recently because the yield curve, well, I don't think it's not inverted anymore, but the Fed-controlled end, the lower end, meaning cash type stuff, is still high. But that being said, still worth it. Can you get creative as far as making sure that yield or even after-tax yield is still good? Absolutely. And should you? As long as you can handle the complexity and you have the expertise, you should do it. So that's the plus. That's the plus.

Then we're going to get to the two buckets that are often talked about with this particular strategy. It's bucket two. And bucket two within these bucket strategies is often a lower risk bucket. They often think in terms of three to five years or three to seven, seven to 10. Where this kind of, I think, somewhat newer strategy is different is that it is truly an income bucket.

Some of the other strategies, basically kind of investing in bond funds or bond ETFs. So what I like about this new strategy that I've heard about, because we do, well, we don't necessarily call it this. We do it more in, we don't separate out the buckets for most folks, but we kind of do the same thing with several years of income. And that is where you buy individual bonds or fixed maturity date ETFs. So the reason with any of these bucket strategies, it's more psychological.

Because anytime, as we're going to talk about, anytime that you are confining what you do with different account types and so forth, you might be sacrificing something. But there is comfort.

So there is psychological security with these for clients. If they can look at a bucket and say, I know that bucket is going to fund my lifestyle and, especially since I have that emergency fund, for the next three years is usually the minimum when you're doing something like this, but five is a common one or even seven, in some cases longer.

I have comfort in that. Comfort cash is the right word, but that sleep at night factor is incredibly powerful, especially for those that are entering retirement. It can allow them to take on higher risk in that third bucket, almost ignore it, if you will.

And especially when you first start retirement, when we talk about sequence of return risk, meaning what happens if you have a bad stock market for an extended period of time, like 2009, Great Depression, or even bad inflation, like in the late 60s and the 70s, it really is only harmful if it happens right after or shortly after retirement, because if you have enough equity in your portfolio.

Assuming your spending doesn't increase, you have some sort of lifestyle creep, you have enough equity growth in your portfolio that once you get 10, 15 years in, it doesn't matter. You've already got a big enough asset base given your standard of living, assuming it doesn't change. So the key with this bucket and why I like it, and I've got to be honest, it's why I'm talking bucket strategies again, is I like the idea of folks gravitating towards individual bonds.

Far too often they aren't used anymore because honestly, they're more work for the client, they're more work for the advisor, because buying an ETF or a mutual fund is very easy. And when you look back at 2022, that's where you saw a lot of harm with folks who would do, say, pure passive investing at Vanguard. Low cost, that's wonderful. But they would look at the blue portion of their 401k or their IRA and say, that's low risk.

That blue portion gives me comfort. That blue portion provides income and they act as a ballast. They might not use the word ballast, but we all know what happened in 2022. That comfort piece dropped 10, 20, 30% in some cases. That's not comforting. And if you're having to sell that fixed income piece at a loss, you know, even if the portfolio says you can do it. And in this case, it only lasted a year or two or so. Some of these still haven't come back and it makes sense.

And with these, when you're talking about these ETFs and mutual funds, because you cannot hold things to maturity, they have to buy and sell these securities. You know, in some cases they're locking in the lower prices. So you don't have the predictability, don't have the control, which from a psychological standpoint and just a portfolio management standpoint, when you own an individual bond, there is comfort in knowing at one year,

I'm going to get that maturity. I get this income along the way. That maturing bond will pay for a year of my living expenses. In year two and three, in this case, quite often you see folks going out to year five. You could see where that is extremely powerful from a psychological standpoint.

Now, and we're going to mention this all the time. Now, again, you don't have to, you can do the same thing in more traditional methods, but you could see where folks that bucket to saying, especially if you're using U.S. Treasuries, you know, and that's where income selection asset or investment selection is critical, but you can use other things as well.

Knowing that you have that income is really, really powerful. And also from a portfolio management standpoint, you don't have to, you know, it does allow even the portfolio manager to say, I can take on more risk in this third bucket because I know I'm not going to have to sell anything. I know that that income is going to be there.

One of the other things I like about this kind of newer approach, if you will, or maybe it's been around for a while and I just haven't run across it, is quite often when folks are using this. That third bucket, they really let it run, meaning, They let it grow. They are not necessarily bound by a 50-50 portfolio, 50% stocks, 50% bonds, 60-40, because all they care about is that they have that income bucket.

Now, again, as we're going to find out, the actual plumbing around this isn't quite as simple as it sounds, but they let that bucket run. And that actually can be a wise thing, is to say we're not going to be bound by this hardcore 50-50. Some of the pro-bucket people will often point to that 50-50, 60-40, though, mistakenly, and will often say, well, if you have a distribution on a 60-40 portfolio, you're selling your equities maybe when they're down.

And if you're using a target date fund, as we've recently talked about, that's true. That's why we often don't like those in retirement. But most advisors I know, even the ones who don't put a lot of effort or thought into this stuff, will sell equities when they're up and use bonds when equities are down. So that argument from the pro-bucket, at least this pro-bucket for folks, I don't necessarily agree with.

One of the other criticisms of folks who use this is that they view rebalancing as not a good thing. And they are at least somewhat right. The main purpose to rebalancing is not to maximize return necessarily, but it is to stick to a risk profile that is good for the client. And that's what most clients want. Like I said, I think there's some wisdom in maybe letting some of the equities run a little bit as long as your income is taken care of and you are comfortable with it.

But if you let income run, if you let these equities run too much, it's what you might have later in retirement is you could have a person that's 80 years old and has 80% equity. And they still might have their income bucket, and maybe they still get some solace there. The problem is when you start getting account values that even if you are mentally able to segregate these two buckets, and you don't care what happens to the third bucket, if they're super high or super low, that's great.

But what you often see is once those values get up there, that 80 or 90-year-old does not want to see that equity bucket drop 40, 50% in a 2009. So part of the pro-bucket folks, what they miss is that the purpose of rebalancing, is not necessarily to maximize return, it's to maximize return for a given level of risk. Because when you look at all these studies, yes, if you simply let equities run, if you start off, one, you're starting off with some level of risk profile. You're not all equities.

So you're starting off with something. So you chose a risk profile for a reason. The other question is, are you okay with that changing? And equities go up over time. So if you give it a long enough timeframe, the equity piece is going to grow and grow, which as long as you plan for that income might work best for you. But part of the reason we do this whole bucket strategy is a psychology around it.

So letting that equity, that third bucket run too much is not a wise move, just because even if someone's comfortable in their 60s or even 70s, once they get to their 80s and 90s, they might not be comfortable having that equity piece be so large, even though they're might be substantially better off doing so.

Keep in mind that the main purpose around rebalancing is more for risk management, than to maximize return. Another thing with these, some of the more advanced bucket strategies is to look at the, a lot of times folks become very religious when it comes to that third bucket, saying it's got to be just equities. Whereas if you did want to try to let that one grow a little bit, be more diversified. So you could use higher yielding bonds. It doesn't even have to be junk bonds necessarily.

It could be alternative strategies like buffered ETFs or covered call strategies, either you're doing the calls yourself or you're doing a covered call ETF, something that has some equity growth type to it, but maybe a higher yield. And again, as we're going to talk about, you always have to keep in mind what assets you have where for tax purposes.

But putting more thought into that third bucket can be great. You could look at REITs, tips, treasury inflation, protective securities. The problem with some of these bucket strategies is that they've just become too religious about what's in there. And anytime you lose some flexibility, you lose the ability to handle risk, taxes, and investment choices often.

But as I mentioned, just having that bucket three and having folks, something in place to allow that to grow, to have the immediate, to have the knowledge that your income is taken care of for years and allowing that risk to grow can be great. That predictability around bucket two is something that I really, really like.

With any of these bucket strategies, one of the issues is how does it actually work? And when you get into how does it work, part of the problem is how do you refill bucket two? Because you're spending it, it's income. So obviously, at the end of year one, your bucket, maybe if you have some inflation adjustment or if you have some yield, it might depend, but you figured it's 20% smaller. So that is where you can look at this and say, I really like this.

I really think this is a great idea from a comfort and because I can take on more risk from a long-term growth standpoint. But the question becomes, how do you refill bucket two? Often folks will take the dividends or capital gains from the equity, from the riskier bucket three and put in there. And that's not a bad idea. But when you think about, I think the SP now is like 1.2, 1.25. So even if you go after.

Some of the things we talked about, if you put in some of the not quite equity pieces or higher dividend docs, like if you get 2% or 3%, well, that's not going to replace a year worth of, especially if you're doing an inflation adjustment, which again, which is another problem with this, especially when you're guessing that inflation.

You think if you had structured a bucket strategy before 2022 and you used some 2.5% or less inflation and you had each maturity date and that adjusted, well, what happens when you have 2022 come along and you have 8%, 9% inflation? So that's where having that 2% or 3% come in can be a good idea. It can help offset some of that. It's more of a cushion rather than being able to actually fully replace income.

Therefore, you most certainly will need to sell some equities from your growth bucket at some point. That's just the bottom line, to replenish your income bucket. I mean, that's the reason we separate the two. What I do see, what I have seen with some folks who use this strategy is they will often, just like there's some flexibility around how risky their portfolio gets. They will often will sometimes delay filling bucket too, depending on what equities do.

So the idea being that you don't want to necessarily sell equities when the stock market is down. 2009, if that equity piece drops 40%, if you can try to delay it a few years, then that's probably the best thing. The whole purpose behind this bucket, too, is that you do have a cushion. And most folks who do this are not going to want to get down to, say, below two or three years. But if you do have some flexibility, the important thing is that you do have rules around this.

Clear rules laid out for you and your advisor. So the idea that you hold off selling equities on smaller moves, like especially three, four, five, even six or 7%, especially in today's world where you see that kind of move on a regular basis, but something like a 10%, which is traditional correction, even though that's not huge, but to say, we will refill the bucket when we are above a certain level, five or 10% up, you need to put some thought into it for a year from the all-time

high, whatever it is, and then we're not going to fill up bucket two when we are down more than 10%. So putting some thought into what that looks like and that makes sure you're comfortable with that. And if you have a bucket, if you have like a 10-year bucket two, 10 years worth of income, there you can certainly let it go further. So that's where setting these up and an actual operation can be tougher than people think.

One of the other complexities that you have is what account types do you use? Is your bucket one a taxable account? Is it a Roth account, a traditional IRA? Part of a truly tax-smart retirement distribution strategy involves strategically taking income from different accounts, different years. And if you say you're someone that is doing Roth conversions during your low income years, another form of complexity, are you going to be able to integrate this into this bucket strategy?

Especially when, as I mentioned, using things like individual bonds can be done in a non-bucket approach. And before you jump into this, also keep in mind what does it look like, especially at retirement. So what you often see is before social security, before RMD, social security often is put off until the late 60s, even 70. Of course, RMDs now start in the early to mid-70s. But when we do retirement planning, we're most often maximizing the distribution that you can take.

Why do we do that? Because we want you to retire as early as possible, as safely, but as early as possible. So when we're modeling this in, we often, there's kind of a safe withdrawal rate is 4% with other distribution schedules that are very safe and valid, you can certainly even get higher, even much higher than 5%.

But when you add in the wrinkle that because Social Security kicks in and that takes the place of your distribution, quite often you are doing at least 5%, even 6%, not necessarily because of any more advanced distribution schedule. But you're doing it because you have to replace your full income in your 60s. And then you're taking a lower distribution amount once Social Security starts in your 70s.

So if you kind of walk through this, if you're doing five years of income, even at 4%, that's 20% of your portfolio. 5% is 25% of your portfolio. And if you go 10 years, you could think, now, not to say that this won't work, but then what account does that go into? If you have your bucket two over several different accounts, you could see where does that still offer the same comfort? Because with bucket strategy, you have to do it all at once.

What does that look like? Are you taking distributions and paying more taxes than you should just to make sure you have everything in that bucket? And for some folks, they might say, you know what, because this provides so much comfort and because I'll make up for it because I would take on more risk in bucket three than I normally would. I can grow those assets that might work, but make sure you're making that informed decision and thinking about how are we actually going to put this together?

The other issue you have as well is we often use something called guardrails, FONA safety net, if you will. Guardrails basically is a dynamic withdrawal strategy. So when we think in terms of maximizing portfolio distribution, if we take out a little bit more when times are good and take out less when times are bad, that dramatically, for most folks, dramatically increases the amount that they can start taking out. And we've modeled this in, the math, the math is the math and it makes sense.

Guardrails can be a really great way of being able to take more money out of your account. Part of the reason we like Bucket 2 is because of predictability.

And if you don't know for sure how much you're going to take out of your portfolio each year, it's still more difficult to do something like a guardrail strategy, even though a guardrail strategy will often allow for much higher distributions, especially initially in retirement, and will still have the same probability of success for longevity.

Your chances in all likelihood by all indications for most folks guardrails is going to allow for you to take more money out and end up with more money because it is dynamic and if the bucket strategy is if you're using the bucket strategy because of because of the predictability that's where it might not work so it's kind of taking a look at you know if you certainly could you kind to kind of mix the two.

It certainly takes some, you know, what other differences, takes them out of the bucket three, the riskier bucket during good times, maybe take less out of bucket two during bad times. Again, that adds some complexity where it might not be right for everyone. The other issue you run into too is there's a big difference between pre-social security and RMDs and post. So say you have your bucket strategy set up. Well, what happens when social security starts, you don't have to take as much.

What does that look like for your investments and what accounts they're in? What happens when RMDs start?

RMDs are coming from those taxable accounts, traditional IRAs or traditional 401ks, whatever the pre-tax money is. How does that fit into your bucket strategy? It's not that it can't work, but what does it look like? At some point, the simple two-plus bucket strategy often becomes more complex and more most people want to have.

You also have the issue that if folks are really religious about being really aggressive in bucket three, where it's just equities, but those free tax accounts make up a big chunk of that. Of those funds, or all, you're going to have RMDs, meaning you're going to have to sell. Now, you could just say, you know what, because over longer periods of time, equities go up, I'm okay selling equities even if it's a 40% drop, but most people don't want to do that, like a 2009.

Most people are going to want in some way to plan for these RMDs, say, you know what, especially if times are good, we're going to try to make sure we raise enough money to cover that RMD, or at least most of it, or maybe we'll have some of the higher, we'll have the dividends go into cash, that'll help cover the RMDs.

Well, again, then if the RMDs were supposed to go into bucket two, or not the RMDs, the dividends were supposed to go into bucket two, some folks might use the dividends to go into cash and help those pay for the RMDs. But as we mentioned, most often when you see a strategy, folks are having the dividends go into bucket two. So again, making sure you're using the right account type and you're coordinating the investments and taxes and everything else with social security and RMDs.

It's not that it's impossible. It's not that it's still not going to be a good thing for some folks. It's just the plumbing of it and the execution often can be challenging.

Look, like all robust retirement strategies, there's a lot to like about the multi-bucket approach. And I personally love the use of an income-filled bucket with fixed maturity date bonds. And the way that clients have that comfort, having that predictability allows for the client to be comfortable, more comfortable with risk. It allows the portfolio manager to have more predictability so that they can manage riskier assets more effectively.

But with most comprehensive of strategies, implementation can be complex. Managing risk, taxes, inflation, as we mentioned, can be challenging, and integrating it with distribution models. If your distribution models are there quite often to maximize so you can retire earlier, that can be challenging. So the main takeaway here is, with any of these multi-bucket strategies, it's going to be a good fit for some retirees. It depends on how much you have, the account types, your distribution.

But you truly need to understand the actual operation mechanics and what you might be sacrificing. Will you be sacrificing some taxes in order to execute this? The answer still might be yes. I still want to do this. It's like when we do Roth conversions and folks might lose out on some property tax rebates or Medicare surcharge or something. As long as they know in advance what they're giving up, a lot of folks are okay with it because it's like anything.

Anytime you do something, there could be a cost, especially if there's a most like comfort attached to it. There is often a cost. Financial planning is all about making an informed decision. So if you put some thought into these different strategies, but not just if you like them, but how do I actually implement them?

If you do these things, you're probably going to have a healthier, a wealthier, and a happier retirement. And if you like what you see, please hit subscribe, share this. And we appreciate any comments. We do try to respond as best we can. Thank you. Have a great summer. Thanks for tuning in. If you enjoyed this episode, make sure to hit subscribe, leave a review, and share with your friends. Share the love. Make sure they have a healthier, a wealthier, and a happier retirement as well.

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