You may have heard about a financial planning method called, “The Bucket Approach.” As far as I can tell was made popular by pioneer Financial Planner, Harold Evensky. The method essentially breaks down income needs into “buckets” based on when you may need the income. One would essentially determine their income need in the near-term, medium-term and long-term, then put their money in vehicles to give them the best odds of producing a reliable income stream in each of these time frames. It helps visualize your money and give it a time-oriented purpose that is aligned with your financial plan. There are several variations of the bucket approach. I will describe a basic three bucket approach and discuss possible investment or savings solutions for each bucket. This approach may not be appropriate for everyone, and I would encourage you to talk with your financial advisor prior to acting on any of these ideas.
Let’s assume there are three buckets:
Short Term Bucket
Medium Term Bucket
Long Term Bucket
First, the Short Term Bucket: Income in 0-5 years
This short-term bucket is the very near term reservoir. There are plenty of interpretations around what “short-term” actually means, and it will vary based on your individual situation. This bucket may house the assets to cover your income needs in this time period. To mitigate a “sequence of returns risk,” these dollars ought to remain very accessible and without much, if any fluctuation, A.K.A: “no, or very little risk.” The first and predominate solution for this bucket would be cash. Keeping a large portion of this bucket in cash should ensure that income is taken care of for a certain period of time, and you won’t have to worry about it fluctuating with the market. CDs also make solid short-term bucket solutions. CDs generally provide higher interest rates than cash, but may have early termination fees if you need access to them. A strategy here may be to have the first 1-3 years of income in this bucket in cash, and 4-7 in CDs. The downside to keeping assets in low/no interest instruments in this bucket is that over time, they are likely to severely underperform inflation. It is imperative to determine the appropriate amount of assets to hold in this bucket, and in which instruments. Other strategies may include: CD Ladders, Bond Ladders, Single Premium Immediate Annuity, Fixed Annuities
Medium Term Bucket: Income in 5-15 Years
This bucket is a tricky one. There are many solutions that may overlap this bucket and the long-term bucket. In fact, many advisors simply use a two-bucket approach, lumping this bucket into the long-term. However, we’ll discuss a few solutions that may make sense to accomplish this. A “fixed income” or bond portion of a globally diversified investment portfolio may make sense to fill the needs of this bucket. Fixed Income is a term to typically to describe bonds or bond funds, or actual fixed income like social security. Annuities may be a prudent solution for providing income in this time frame. There are many different types of annuities and you’ll want to consult with an independent and bias-free financial advisor to determine if it makes sense and which specific product makes sense. Annuities may also provide a fixed income amount well into the long-term time frame as well.
Other strategies may include: CD Ladders, Bond Ladders, Diversified investment portfolio, Fixed Annuities.
Long-Term Bucket: Income in 15-30 years
Here you may want to consider having a portion of your overall assets invested in a globally diversified portfolio, including equity mutual funds (or stock mutual funds). Over extended periods of time, the asset class that has historically had the best success of beating inflation has been equities, or stocks. Inflation is the silent killer that has eroded the purchasing power of assets for decades. A plan to combat it ought to be a part of your overall plan and having a portion of your assets allocated here may make sense.
Other strategies may include: Diversified investment portfolio, Variable or Fixed Annuity, Deferred Income Annuity
All of these bucket solutions can be used to have an actionable plan to supplement other income sources, like Social Security, pension payments, etc.. You could use multiple approaches in each bucket or none of them. Perhaps nothing more than a globally diversified, regularly rebalanced, managed 60/40 (60% stock mutual funds/40% bond mutual funds) portfolio is right for you. There is plenty of research pointing to the success of that strategy, over extended periods of time. In all, creating a retirement plan that is effective, means creating the plan works for YOU. It means that you are able to sleep peacefully at night not worrying about your money, or where your income will come from in 2, 10 or 20 years. It means that you are able to live life on your terms. You can do this strategy yourself, or hire qualified advisor to help. You just might find the right strategy that works best for YOU. It just takes a little time and work.
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