Investing Specialists

The Bucket Approach to Retirement Portfolio Construction

Christine Benz

The bucket approach to retirement portfolio planning is a strategy for funding retirement cash-flow needs while also maintaining a diversified portfolio of stocks, bonds, and cash. The overarching idea is to set aside one to two years' worth of living expenses in cash (bucket 1), while using additional buckets to hold more volatile assets with higher potential returns for the later years of retirement. This article provides an overview of the bucket strategy. In this video, Harold Evensky, a well-regarded financial planner who created the bucket concept, discusses his take on the bucket strategy.

I've created a series of model portfolios that showcase how one might implement the bucket strategy. Each portfolio includes a cash component (bucket 1), an intermediate-term component consisting mainly of bonds and balanced funds (bucket 2), and a long-term component for growth, featuring stocks and higher-risk bond types (bucket 3). The size of the buckets varies by time horizon.

There are three portfolios consisting of traditional mutual funds: aggressive, moderate, and conservative. I've also crafted three exchange-traded fund bucket portfolios: aggressive, moderate, and conservative, as well as a group of tax-efficient buckets

Although the portfolios have only been around since late 2012, we conducted some performance tests to see how they would have withstood various market environments. Did they fund retirees' cash-flow needs while also holding principal steady, or even growing it? The answer is yes. We stress-tested several scenarios and time periods--2007-2012, 2000-2013, and varying implementation and rebalancing strategies--and found that the portfolios generally met their goals of providing in-retirement cash flow and growing principal.

One of the key aspects of keeping a bucket system up and running is having a plan for bucket maintenance--specifically, replenishing bucket 1 as it becomes depleted and rebalancing buckets. There's no single-best way to maintain a bucket portfolio: one can re-fill bucket 1 with income and dividend distributions (rather than reinvesting them) or re-fill bucket 1 with rebalancing proceeds alone. This article discusses various approaches to bucket maintenance.