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By Christine Benz | 03-23-2010 01:02 PM

The Bucket Approach for Retirement Income

Making a bucket for shorter-term income needs can secure peace of mind (and prevent poorly timed sales) during volatile times, says noted planner Harold Evensky.

Christine Benz: Hi, I'm Christine Benz from Morningstar.com. I am here today with Harold Evensky. Harold is President of Evensky & Katz Wealth Management. Harold, thanks so much for being here.

Harold Evensky: Thank you.

Benz: Harold, you were really a pioneer in terms of what has now been called this bucketing concept for managing retirement income. Can you talk about the bucketing approach and why you think it makes sense for retirees who are managing their portfolios?

Evensky: The fact of the matter, it really makes sense for anyone. I think we believe that the risk of investing in the market is the short-term volatility of the market. So we developed back in the early '80s I think we call our five-year mantra; "five years, five years, five years," simply means we don't believe anyone should invest money that they are going to need in the next five years. Too much risk...

Benz: Stocks or bonds.

Evensky: Stocks or bonds, too much risk that they will need at the wrong time. So, we carve out for any lump sum, someone says, "Gee, I want to buy a second home three years from now," we will carve that out of the investment portfolio and put it in short-term bonds or cash. When it comes to retirement income, someone says, "Gee I got a million dollars, I need $50,000 year out." And trying to figure it out, carving five years' [worth] of cash flow is, there is too much opportunity cost, all that money sitting in cash, so we experimented and came up with two years. So I said, "OK, put two years in cash, take the other, the $900,000 and invest it in a total return portfolio."

What that does is you can take that cash and set it up to pay your check once a month like a payroll check. The market can be volatile, but you know where your grocery money is coming from, so you are not going to get panicked [about] what is going down. As you manage your investment portfolio, gets out of whack, you need to rebalance, you look over and say, "Gee, it's kind of down, let me move some money over."

So you can be much more cost and tax efficient in managing that portfolio. You are not going to have to sell at the wrong time. You can sleep through volatile times. As a client said, "to make sure I understand, I don't have to be happy but I don't have to worry."

No one is going to be happy losing money, but we did this prior to the '87 crash, clients came through well, tech bust and recently, so it is a very effective strategy of minimizing the risk of taking the money out at the wrong time. It's really a fairly simple idea.

Benz: Right. So now I think I have heard some advisors putting forth as many as eight separate buckets, how many buckets, so say you are a do-it-yourself investor managing your own retirement portfolio, what would be a sensible number of buckets?

Evensky: Basically two.

Benz: Two.

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