Saving money diligently for retirement, accumulating a substantial fund, is a laborious task. To ensure a steady stream of income from these savings and shield them from market fluctuations, tax law changes, and longer life spans, employing the “3-Bucket Strategy” can help safeguard your retirement lifestyle.
So, what exactly is the 3-Bucket Strategy? It’s a strategy that stabilizes cash flow by diversifying and prioritizing different funding sources. Mastering this method can assist in both growing funds during retirement and preserving the principal amount.
The 3-Bucket Strategy categorizes investments into three types: short-term, medium-term, and long-term. This classification helps shield against market volatility. During market downturns, you can withdraw funds from conservative or cash-like assets for emergencies.
This approach protects higher-risk investments, such as stocks, from being forcibly liquidated during market lows.
The 3-Bucket Strategy can be adjusted flexibly according to individual needs.
According to Bank of America, the short-term bucket is for immediate expenses like mortgage payments, groceries, utilities, etc. Social security income also falls under the short-term bucket.
However, Peak Financial defines the short-term bucket from an investment perspective as predominantly holding low-risk, short-term maturing assets like cash savings accounts, certificates of deposit (CDs), and money market funds.
These funds must avoid market risks while remaining easily accessible.
It is recommended to reserve funds equivalent to 1 to 5 years of living expenses in these low-risk, highly liquid assets.
The second bucket can be used for non-essential or unexpected expenses such as travel, vehicle purchases, grandchildren’s education fees, and more.
Funds in this second bucket should be invested in conservative to moderate-risk products that at least keep pace with inflation.
Investment options may include 2 to 10-year bonds, longer-term CDs, preferred stocks, dividend-paying stocks, and Real Estate Investment Trusts (REITs).
The aim is to outperform or at least keep up with inflation while safeguarding the principal amount without taking on excessive risks.
Ten years later, you can start contemplating long-term goals such as moving into retirement communities, long-term care, or leaving an inheritance for children. This bucket’s focus is primarily on long-term growth.
This bucket carries relatively higher risks as the funds are left untouched for over 10 years, aiming for significant asset growth.
Investments may include growth stocks, small-cap stocks, emerging market stocks, high-yield bonds, and index funds (e.g., tracking the Nasdaq Composite Index or S&P 500 Index).
Suitable investment options include growth stocks, small-cap stocks, emerging market stocks, high-yield bonds, and index funds (like those tracking the Nasdaq Composite Index or S&P 500).
However, these funds are not left static in the long-term bucket. As funds are utilized from the medium-term and short-term buckets, the long-term bucket is gradually replenished to sustain daily living expenses.
Before implementing the 3-Bucket Strategy, it’s crucial to estimate your retirement expenses. You can start by calculating your current expenditures and factor in any downsizing plans.
Consider future inflation factors as well. You can seek assistance from fee-transparent, trustworthy financial advisors to help with the calculations.
Once you have a clear understanding of your expenses, you can begin funding the three buckets accordingly.
As per Charles Schwab’s recommendation, the three buckets should be divided based on timeframes:
– Short-term bucket: 0 to 5 years of expenses
– Medium-term bucket: 6 to 10 years
– Long-term bucket: 11 years and beyond
Remember, the short-term bucket’s funds should consist of money or cash equivalents. For instance, if your annual living expenses amount to $30,000, your short-term bucket should hold $150,000 for the first five years.
Funds in the medium-term (6 to 10 years) and long-term buckets (11 years and beyond) should be allocated based on your investment portfolio.
If your total retirement fund is $500,000, allocate $150,000 to the short-term bucket initially, then distribute the remaining $350,000 among the medium-term and long-term buckets. The distribution need not be uniform, but ensure it meets future needs.
Avoid excessively expanding or shrinking any bucket. It’s best to rely on a trusted financial advisor to help you reallocate investments promptly with changing market conditions.
As you step into retirement gradually, your long-term bucket may require transferring funds to the medium-term bucket, making this adjustment critical.
This bucketing strategy prevents selling investment assets during market downturns, ensuring a stable and smooth retirement plan.
It’s a structured strategy that simplifies complex issues, aligning your investment approach with real-life scenarios.
Managing the three buckets requires time and effort. It leans towards a conservative approach, potentially causing anxiety when cash sits idle during market upswings.
Additionally, individuals with smaller asset sizes may find the application of this strategy limited.
This retirement strategy divides your retirement funds into three buckets, arranged by risk level and liquidity, to cater to different stages of financial needs.
Its ultimate goal is to ensure a stable income source during retirement while maximizing the protection of your principal from market fluctuations.