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Retirement Buckets and Volatility

Last week’s article was about spending in retirement. I was really surprised how many opens I saw on my email software. Although I have been sending out articles weekly for years, I swear I still do not have  a solid grasp on what will be of interest. Regardless, I am going to build off of that article and combine it with a financial planning concept I wrote about a long time ago – buckets. And I’m not talking about pickle buckets, which I promise I will explain at the end. 

We saw some serious volatility last week in the market. I don’t have numbers on the Dow and S&P500, however, NASDAQ was down more than 3% at one point on Friday and finished up more than 3%. We haven’t seen that sort of swing in roughly 15 years. And if you are looking too closely at your investments this year you know we have had lots of volatility. Most of the cause before was due to inflation and unknowns about interest rate changes. Now we add the Ukrainian invasion into the mix and things have intensified. 

I’m mentioning volatility because with the concept I want to discuss today, volatility of the Dow, S&P500 and NASDAQ shouldn’t really matter. At least in the short-term. 

Buckets are something I use for some of my clients. They aren’t designed for those accumulating assets, but more for those within a few years of retirement. The concept is simple, however, the execution is more complex. Hence the reason I get paid the “big” bucks😉 

Here is the concept in a nutshell. You divide your investments into buckets. The number of buckets is really up to you. However, I use three in my plans. First bucket is the most conservative. Bucket two is a little more aggressive, but still conservative. The final bucket is the most aggressive of the three. 

Here is where the complexity starts to come into play. How much money you should have in each bucket is based on things like spending, rates of return, inflation, income sources, taxes and a few other items. The most important factor into determining your bucket allocation is once again the item I focus on the most with retirement – your spending number. Without knowing your spending number we are just guessing randomly. 

I won’t get into the nitty gritty details as no one wants to see how the sausage is made, however, let’s go back to making this simple. 

The goal for the first bucket is to use this to fund any income needs you have the next few years. Hence the reason it is so conservative. No reason to take any sort of risk with that part of your investments you plan to access the next couple of years, right? 

Bucket two is still conservative, however, it makes sense to get a little more aggressive as you won’t be touching these funds for a few years. Maybe you can add in a little bit of stocks, but on the more conservative side. You know, large cap values instead of emerging markets. No reason to invest in the Russian stock market when you could invest in things like GE, WalMart, and McDonald’s. Let me stress a couple of points here. Again, this bucket is the second bucket so you won’t be touching it for a few years, but it is still on the shorter-end of your retirement timeline so don’t go too crazy. 

The third bucket is the one you won’t touch for who knows how long. I run my bucket strategies anywhere from 8-12 years before a client touches this third bucket. Because of this we can be more aggressive. Now, aggressive is definitely subjective. For some bucket modeling the third bucket may be 80% in stocks and others are 50%. It all depends on the client. Again, I don’t work in a one-size-fits-all world where I shove clients into my models. I build around them. Regardless, this bucket is where the aggressiveness of your overall portfolio lies. 

Here is the key with the third bucket and the whole bucket strategy. If the market gets all wonky (official financial planning term) with volatility, the biggest moves are most likely in your third bucket as this is the most aggressive one. This bucket is one you will not touch for at least 8 years, or maybe more. The funds you are going to need in the near future are much more conservatively invested in buckets one and two. 

One final thing to mention with how this whole bucket strategy works. We can now use the old concept of “trickle down.” Basically, if buckets two or three are doing well you just take some of the gains and roll them down a bucket. See, Reaganomics finally works😉  For example, the third bucket has a nice year you can grab some of the growth and move it down to replenish the second bucket. Then your second bucket may be a little overweight, so you shift some of this bucket down to the first one. If the third bucket is not having a good year, you know you are okay because the first and second buckets are full and these are the sources you need for the next 8ish years. 

Again, this is a high level explanation of how buckets help your flatten out portfolio volatility issues when it comes to your retirement spending. This is a concept financial planning experts talk about every so often in my world. I can say I find it very useful in my practice, especially times like this when the market is bouncing around so much. 

A few final thoughts. 

  • First, it is key to meet regularly with your CFP®.  That old Ferris Bueller expression comes to my mind about life moves fast. Expenses change. To make the buckets work you and your CFP® need to make sure the plan is current. This is why I meet four times a year with clients. Meeting once a year just doesn’t work, even though that is what most advisors do.
  • I am going to sound like the old broken record here, but know your spending. Both short-term and long. Data out is only as good as data in.
  • Don’t try and carve out gains too frequently. I lean toward rebalancing the buckets once a year, but definitely not more than twice a year. Yes, one offs make sense like for an unplanned expense. Otherwise, you need to let the investments do what they are designed to do.
  • Finally, and this is the big benefit of buckets from a behavioral finance perspective – don’t focus too much on what the stock market is doing. Instead of looking at your investments twice a day or even once a week, spend that time on refining your spending. The market is impacting the bucket you aren’t planning to touch for years, so no reason to obsess here on funds you aren’t touching for quite some time.

 One final comment with buckets and this goes to executing this strategy. Most financial planning software is not built to execute retirement buckets. I don’t know why, but that is the world I live in. I’ve spent a ton of hours building out my bucket spreadsheets and am constantly refining them. Actually, I will be doing a big upgrade to them this year. My point is there aren’t many of us out there executing this strategy. Which is too bad as I think there is a big need for it as I and my clients have found it extremely beneficial. 

This seems like a good place to stop. However, I promised the pickle bucket story and I will keep it brief. I spent a summer working at Cedar Point when I was in undergrad. I spent most of my summer there working on the train, which was a coal-burning, steam locomotive. The job at the end of some shifts was to fill the tenders (I think that was the name) with coal for the next day. We had a huge pile of coal that would be replenished regularly. To move coal from the pile into the tender we used pickle buckets. These were huge buckets that had previously been filled with pickles for the various food spots throughout Cedar Point. Think of them as much bigger versions of the utility buckets you buy from Home Depot. We scooped coal from the main pile into the former pickle buckets, carried the now coal buckets over to the tender, and then filled the tender box up for the next day. See, and you thought you were just here for retirement bucket knowledge😊

I’m Dan Johnson, CFP®, founder of Forward Thinking Wealth Management. I run a flat-fee financial planning and investment management firm located in beautiful Akron, OH. Although I am in Akron, OH, I work with clients regardless of location. I cater to owners of equity compensation positions who are looking to organize their financial lives, keep more of what they make, and do the things they want in retirement and even now.