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5 min read

Should Investors Use a Bucket Strategy for Retirement Income?

Morningstar researchers analyze and compare five common approaches.


Key Takeaways

  • The systematic withdrawal strategy provides a high plan success rate and ending wealth. 

  • The cash flow reserve bucket strategy and the two variations of the three buckets strategy underperform the systematic withdrawal strategy due to the opportunity cost of placing the first few years’ worth of spending in cash or bonds. However, the three buckets strategies could handle the ending wealth shortfall risk and provide relatively high growth potential with proper decision rules in place. These strategies are best used by investors who are likely to overreact to market volatility. 

  • The time bucket strategy offers the highest viable retirement spending and ending wealth along with the largest variation in outcomes because of the high equity concentration in the later phase of retirement. The strategy is best used when an investor is willing to take more risk in exchange for a boost to their retirement income.

Preparing for retirement can look different for every client. And when it comes to a retirement income strategy, there’s no one-size-fits-all approach. What type of plan may be the right choice for your investors?

Despite a wide range of options, the systematic withdrawal strategy and the bucket strategy are common choices for retirement income planning. With a deeper understanding of these approaches, you can help your clients avoid common assumptions—and make better decisions for the future. Morningstar researchers compare the systematic withdrawal strategy against four major bucket strategies: the cash flow reserve bucket strategy, two variations of the three buckets strategy, and the time bucket strategy.

To read the full research report, download a copy here.

A Breakdown of Retirement Income Strategies

Considered easy to communicate and understand, the systematic withdrawal strategy assumes investors have a constant equity and bond allocation consistent with the client’s risk tolerance. Financial needs are funded every month proportionally from both the equity and bond assets, and the portfolio is rebalanced according to a predefined decision rule.

In comparison, the basic idea of bucket strategies is to establish multiple asset buckets with different levels of risk and funding purposes. By separating assets to fund near-term financial needs and to generate long-term capital growth, clients may be more comfortable investing in a risky portfolio with higher growth potential.

For example, a cash flow reserve bucket strategy places one year of retirement spending in a cash bucket and the remaining assets invested in other buckets with an asset allocation matched to the client’s risk tolerance. A three buckets strategy is where Bucket 1 is used to fund the first one or two years of retirement spending, Bucket 2 contains investments to fund five to eight years of retirement spending, and the last bucket is used to fund the remaining years of spending. Another approach, known as a time bucket strategy, divides the portfolio into four buckets that cover equal amounts of retirement periods with a legacy bucket for other goals.

Here’s a closer look at how these four strategies for retirement income perform.  

Viable monthly spending amount

When considering viable monthly retirement spending amounts, the time bucket strategy stands out slightly from the other strategies. 

As seen in the chart below, the time bucket strategy has a viable monthly retirement spending of $6,206 at an 85% funding success rate while the systematic withdrawal strategy viable monthly retirement spending is $5,898. This may be due to the large equity exposure in the last bucket. As there’s no rebalancing within the buckets, the overall asset allocation increases to 100% equity after year 10 when the first two buckets are retired.

Yet, the systematic withdrawal strategy provides $2,343 more in viable spending than the cash reserve bucket strategy. One explanation for why the cash flow reserve strategy underperforms is the opportunity cost of always placing one year’s worth of retirement income in cash. And given the limitations of the decision rules in our bucket strategy modeling, it may not be surprising that the two variations of the three buckets strategies provide the lowest viable spending.

Viable monthly spending by systematic withdrawal, CFR bucket, three bucket A, three bucket B, and time bucket strategy.

Sequence risk management

The sequence of investment returns—which occurs when retirees must liquidate depressed assets in a bad market at the beginning of retirement—can add risk to household financial outcomes. Some bucket strategies could improve financial outcomes by preserving depressed assets, particularly in the beginning of the decumulation phase. 

Our chart below shows the viable monthly spending amount provided by different strategies when the client retires in a bad equity market. Compared with the base scenario summarized above, all strategies provide slightly lower sustainable spending amounts. Still, the time bucket strategy offers the highest spending under bad conditions at all success rates.

On the other hand, the differences in viable spending amount narrow between what’s provided by the systematic withdrawal strategy, cash reserve bucket strategy, and the three buckets strategies. The relatively benign impact of the sequence risk here may be because our analysis is based on 150 hypothetical retirement starting dates that have the worst first six-month returns in the historical data. We assume a monthly withdrawal, which minimizes the impact to the investment portfolio even when it is depressed.

Viable spending by systematic withdrawal, CFR bucket, three bucket A, three bucket B, and time bucket strategy.

Consequence of investor overreaction

When a client’s near-term spending is affected by the current market performance, it could lead to an irrational decision and the client withdrawing from the equity market. However, the cash flow reserve bucket strategy and three buckets strategies cater to a client’s mental-accounting needs and creates a bucket for near-term spending and long-term asset growth. Under the systematic withdrawal strategy, one portfolio is used to fund both near- and long-term financial needs. 

Our chart shows that if a client exits the equity market after a negative 20% quarterly return, the investor’s monthly retirement spending could be reduced by about $2,000, equivalent to a $24,000 reduction in annual spending. When accounting for the investor overreaction, outcomes from the systematic withdrawal strategy are lower than what’s provided by the cash flow reserve bucket strategy and the three buckets strategies. This supports the behavioral benefit of a cash flow reserve bucket strategy. Even if these strategies produce a lower viable spending amount, it could be valuable if investors are prone to behavioral bias and irrational decisions.

Viable monthly spending by systematic withdrawal, systematic withdrawal (return drop by 15%), systematic withdrawal (return drop by 20%), CFR bucket strategy, three bucket A, and three bucket B.

Better Support Your Clients

Every client has unique priorities for retirement income planning. When you understand what matters to your clients, you can find a retirement income strategy that aligns with their goals.  

Deliver your service on a wider scale with Morningstar Advisor Managed Accounts. The platform allows you to strengthen client relationships and offers a holistic experience with the support of Morningstar Retirement Managera user interface that gives tailored savings and withdrawal advice.

Get in touch with a specialist today.