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By Christine Benz | 06-26-2013 01:00 PM

Cashing Out of the Bucket Strategy

Financial-planning expert Michael Kitces cautions retirees about holding too much cash in their portfolios, as simple rebalancing of stocks and bonds can provide needed income.

Christine Benz: Hi. I’m Christine Benz for Morningstar. Bucketing strategies for retirement planning have taken off in popularity in recent years. Joining me to discuss the pros and cons of bucketing is Michael Kitces. He is a financial-planning expert.

Michael, thank you so much for being here.

Michael Kitces: Thanks, Christine. Great to be here.

Benz: Michael, let’s start talking by about why it seems that the light bulb really goes off in a lot of retirees’ heads when you start talking about segmenting that portfolio by time horizon. What do you think works about bucketing from a practical standpoint?

Kitces: I think the strongest thing about bucketing from the practical standpoint, it just fits with the way our brains work. We have this growing volume of research now, what we call the behavioral-finance research, and the particular version of this is called mental accounting, which basically is we tend to form lines and we make buckets around how we allocate and manage information in our heads. And that definitely includes how we treat our investment accounts.

So we see sort of the funny anecdotal stories like "I’ve got two $50,000 accounts. One is my checking account for my spending, and the other is grandma's inheritance. And I treat them completely differently because grandma always wanted me keep this money for a special occasion, whereas this is my spending account." The reality is they’re two $50,000 accounts, they’re cash, they’re liquid. They’re the exact thing. But we start accounting for them and tagging them in very different ways, and then really treating differently.

Some of that, I think, we do automatically because of the rules that we have. We tend to mentally bucket retirement accounts differently than spending accounts, which is easy because the spending accounts are usually at a bank and the retirement accounts are often IRAs and 401(k)s held elsewhere anyways. So some of that is easily conducive. I find it gets messy when we get to retirement though because suddenly everything funnels down to one big bucket; "My retirement bucket has got all my different monies."

Sometimes we literally consolidate accounts. We certainly start viewing the balance sheet a little bit more holistically. Then we find it starts to get a little bit messier, where we kind of want to still account for things in buckets, but we've consolidated everything down to one big pool that it gets a little bit challenging, I think, for retirees trying to get comfortable with "How do I live off of this one big pool of money that's sloshing around as markets do what they do?"

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