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If you view retirement as a short-term state, you may be shortchanging your retirement years. For many retirees, retirement may last 30 years or more. How you manage the money you will need today may be quite different from how you treat the money you’ll need in 20 or 30 years.
“When people hear the words ‘asset allocation,’ they think of it mainly in terms of getting to retirement age,” said Dung Vu, a financial professional with Goldbook Financial in Costa Mesa, California. “But your asset allocation strategy doesn’t end at the start of retirement. It morphs, expands, and needs to be managed all the way through.”
To fully prepare for all your retirement years, one tactic may be to consider dividing your assets into three buckets, each representing about 10 years of your potential 30-year retirement.
This is the retirement bucket strategy. And many find it a useful way to approach investment and income questions in their retirement years. Indeed, many people opt to discuss this approach with a financial professional when formulating a retirement plan.
Will it work for you? First, take a closer look at it.
1. The Money Now Bucket
This will cover the first 10 years of your retirement, when you’re most likely to lead an active lifestyle. You may want the assets held in this bucket to be accessible — more liquid — so you can take advantage of your newfound freedom to pursue the things you’ve always wanted to do, such as travelling, focusing on favorite pastimes, or new hobbies.
Your asset allocation may follow a conservative approach, with a higher portion of your assets in cash or cash equivalents. Other holdings might include high-yield savings accounts, money market funds, short-term Treasury bills, and certificates of deposit.
2. The Money Later Bucket
This will hold money you may spend during the second 10 years of retirement, when you begin to slow down and settle into routines closer to home. You may want the assets held in this bucket to provide a targeted return on investments. The potential return generated from these assets should strive to at least keep pace with inflation.
To that end your asset allocation may follow a more balanced approach, with a focus on securities that may provide a fixed return and an opportunity for growth. This could include investment-grade bond holdings and bond funds as well as dividend-paying stocks. Annuities could also be a good option for this bucket as well.
3. The Money Much Later Bucket
This will hold the money you may spend during the third 10 years of retirement, when you’ll most likely be focused on healthcare needs or providing care for a loved one.
You may want these assets to be growth oriented as you may not need to access them for 10 to 20 years depending on when you retired. Growth of assets over a longer-term period may be critical to be prepared for the often necessary, and ever-increasing, health care expenses associated with living a long life.
Your asset allocation may follow a more moderate-to-aggressive investment approach that aims to provide growth, but still gives you peace of mind. Diversified stocks, index funds, certain mutual or exchange-traded funds (ETFs), or real estate investment trusts (REITs) could fit this category. Investing in a qualified longevity annuity contract is also a possibility for this bucket.
Using the buckets
So, using this 3-bucket approach, a retiree facing around $50,000 in yearly expenses with $1 million in savings might divide their funds roughly by thirds into each of the buckets.
Then the retiree would use the first bucket — the Money Now Bucket of highly liquid assets like cash or ordinary savings — for day-to-day expenses or hobbies and travel.
Then, after about a decade or so, the retiree can switch to money from the Money Later Bucket, where funds have been hopefully growing in medium-term, moderate-risk, investments like bonds. (Practically speaking, this would involve cashing out those medium-term funds and moving them over to the first bucket vehicles like savings accounts or money-market funds.)
This can also be the point where a retiree may elect to start receiving income from an annuity through annuitization.
Then, after another decade or so, that retiree can start tapping funds from the Money Much Later Bucket, shifting money over from investments aimed at long-term growth, like equity funds. (Again, this would involve transferring long-term investment funds into first bucket vehicles.)
Of course, how much goes into each bucket in the first place depends on the circumstances and risk tolerance of the retiree. Also, the timing and withdrawal rate from each bucket would be influenced by a number of factors including income from other sources, like pensions or Social Security, as well as taxes. (Related: 5 retirement tax planning strategies)
Conclusion
Review your retirement asset allocation strategy to see how you may take these three buckets into account. Remember, however, that this is just one of many possible approaches. There are other strategies that may be better suited to certain individual circumstances or lifestyles.
Indeed, some opt to consult a financial professional to assess all the options available and the risks involved with various types of investments and strategies. (Learn more: Protecting yourself against market fluctuations in retirement)
By taking the long view now, you may find yourself on stronger financial footing as you move through each stage of retirement.
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