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Retirement bucket basics

Matt Coffina  |  30 May 2016Text size  Decrease  Increase  |  

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Matt Coffina CFA is the US-based editor of the Morningstar StockInvestor newsletter. This article initially appeared on the Morningstar US website.


One of the most common requests Morningstar StockInvestor editor Matt Coffina receives from his subscribers is to provide guidance on asset allocation. In the most recent issue of the newsletter, he spoke with Morningstar's director of personal finance Christine Benz about the bucket approach to retirement investing. Below is an excerpt of that interview.

Matt Coffina: Let's start with the basics. What is the bucket approach and how does it differ from other common asset allocation philosophies?

Christine Benz: The bucket approach is mainly useful when setting up your retirement portfolio. It can be a helpful overlay, no matter what strategy you're using for selecting individual securities. The basic concept, which was developed by financial planning guru Harold Evensky, is that retirees can benefit from holding a cash component ("bucket 1") alongside their long-term stock and bond portfolios.

Having those liquid assets--enough to supply one or two years' worth of living expenses--can prevent retirees from being forced to sell any of their long-term portfolio holdings at depressed prices. And, of course, holding some cash can also provide peace of mind.

In the model portfolios I've worked on, I include two "buckets" in addition to cash: one for bonds and other assets appropriate for intermediate-term horizons, and one for stocks and other truly long-term assets.

The advantage of having three buckets--cash (bucket 1), intermediate-term assets such as bonds (bucket 2), and long-term assets like stocks (bucket 3)--is that a retiree can readily see which parts of the portfolio have appreciated the most and could be pruned for living expenses.

Coffina: So how does this work in practice? If an investor withdraws her living expenses from bucket 1, how does that bucket get refilled?

Benz: The devil is in the details! First, what you're not doing is constantly moving money from bucket 3 (stocks) to 2 (bonds) to 1 (cash). That's too complicated and too much work. Nor are you spending sequentially through the buckets--cash first, then bonds, then stocks. That could leave you with a stock-only portfolio when you're 80, which is not what most retirees want.

I recommend retirees spend from bucket 1 each year and then replenish the cash as it becomes depleted using a combination of income from stock dividends, interest on bonds, and rebalancing proceeds.