How Do You Maintain a Bucket System for Your Retirement Portfolio?

Key Takeaways

• Bucket strategies are sometimes called time segmentation strategies. The basic idea is that you organize your portfolio and determine its asset allocation based on your proximity to needing the funds in that portfolio.
• For retirees with cash flow needs, the first spot to look is nonportfolio income sources like Social Security.
• A common misconception about bucket maintenance is that the retirees spend sequentially from each of those buckets, but I really like the idea of retirees being opportunistic, taking a step back each year and saying, “OK, if I need cash for my portfolio, what is the best thing to do for my portfolio in terms of where I source those cash flows?”
• When it comes to income distributions the portfolio might generate, there might be some market environments where you’d want to be quite careful about reinvesting those income distributions.
• If the retiree has holdings in taxable, tax-deferred, and Roth accounts, a general framework for spending is that taxable accounts would go first in the queue and that Roth assets would be in the save-for-later bin, but you probably don’t want to just mow them down sequentially, either. Overlay the Bucket structure across your different tax silos.
• For most retirees, once a year is adequate to perform bucket maintenance.

Margaret Giles: Hi, I’m Margaret Giles at Morningstar. Many Morningstar.com readers have heard about the Bucket approach to managing retirement portfolios, but they have questions about how to maintain them. Joining me to discuss that topic is Christine Benz. Christine is Morningstar’s director of personal finance and retirement planning, host of The Long View podcast, and author of the bestselling book, How to Retire: 20 Lessons for a Happy, Successful, and Wealthy Retirement. Christine, thanks for being here.

Christine Benz: Hi, Margaret. Great to see you.

How the Retirement Bucket Strategy Differs From a Standard Retirement Portfolio

Giles: Before we get into the topic of bucket maintenance, let’s discuss the bucket strategies. What is a Bucket portfolio, and how might it be different than a standard retirement portfolio?

Benz: Right. Bucket strategies are sometimes called time segmentation strategies, and the basic idea is that you are organizing your portfolio and determining its asset allocation based on your proximity to needing the funds in that portfolio. In my typical bucket structure, I talk about holding one to two years’ worth of anticipated portfolio cash flows in cash assets. It’s the only asset that is guaranteed to have a positive return over such a short time horizon, and then with the remaining portfolio, you just step out on the risk spectrum a little bit. With another five to eight years’ worth of portfolio cash flows, you might hold high-quality short- and intermediate-term bonds. So, yes, a little bit of volatility potential with that portion of the portfolio, but probably better return potential over long periods of time with that high-quality fixed-income bucket. And then with the remainder of the portfolio, for years, say, 10 and beyond of portfolio spending in retirement, you could hold more aggressive, volatile assets, namely stocks. With that portion of the portfolio, I typically park it in a globally diversified equity portfolio. If someone held any sort of high-risk other assets, whether commodities or gold or something like that, I would probably put it in that long-term bucket as well. The idea is by really kind of visualizing why and how you are apportioning your assets across these asset classes, it just gives you peace of mind through a lot of different market scenarios.

Why Retirees Should Spend From Social Security Versus Their Cash Bucket

Giles: Are retirees spending from that cash bucket, or Bucket 1, on an ongoing basis, and is that where they go for cash flow needs?

Benz: Well, not necessarily. I would say your first spot, if you’re retired and actively spending, is to look to nonportfolio income sources, so Social Security for most of us. People who have pensions would use them to source perhaps the majority of their anticipated income needs. And then you would turn to the portfolio, and even then, the cash bucket wouldn’t necessarily be my first source of funds. You would leave it up to the market environment. Following 2023 and 2024, which were great equity market environments, for most retirees, pulling from appreciated equity assets was a good source of cash flows. In other environments, 2022 was a good example; you might actually be pulling from the cash assets because bonds were down, stocks were down, but you wouldn’t typically turn to cash unless your stock and bond portions of your portfolio were in a bit of a trough.

Why Retirees Should Be Opportunistic When Spending From Their Retirement Portfolio Buckets

Giles: Got it. You note a common misconception about bucket maintenance is that the retirees spend sequentially from each of those buckets. Can you clear that up?

Benz: Right. I think it’s sort of a logical leap for people to jump to, that they would just kind of mow them down, that you would start with the cash, then move on to bonds, and then move on to stocks. But I really like the idea of retirees being opportunistic, taking a step back each year and saying, “OK, if I need cash for my portfolio, what is the best thing to do for my portfolio in terms of where I source those cash flows?” I do think it’s a common misconception that you would just spend through the buckets. There may be periods of time, the 2000s were a great recent example, when you might have done just that, where stocks went down at the beginning of that time period and basically flatlined for a whole decade. It would have been really helpful to have cash and bonds to pull from and to leave your stocks to recover when the market eventually did, but in many different market environments, you probably wouldn’t do that.

Should Retirees Reinvest Their Retirement Portfolio Income Distributions?

Giles: How about income distributions that the portfolio might generate? Should retirees spend those or reinvest?

Benz: I’m kind of agnostic on this point about which strategy they employ. I do know that many retirees derive peace of mind from knowing that at least part of their cash flow needs are coming from income-producing securities. I think that’s why we see such a persistent interest among our readers and viewers in dividend-paying stocks. They like the idea of that bird in the hand. The only point I would make is that there might be some market environments where you’d want to be quite careful about reinvesting those income distributions. So, 2022 was a great example. As I mentioned, stocks were down, bonds were down. Ideally, if you can spend from the cash assets in a period like that and reinvest any income distributions that you’re getting from your stock and bond positions, that gives you the opportunity to put those income distributions to work to help take advantage of undervalued stocks and bonds at that point in time.

How Bucket Investors Should Handle Spending From Traditional Tax-Deferred, Roth, and Taxable Accounts

Giles: You’ve already mentioned selling appreciated assets, potentially. How does tax management fit into all of this? If the retiree has holdings in taxable, tax-deferred, and Roth accounts, what’s the order that they should be spending?

Benz: Right. I think people hear about this three-bucket system, and it seems so simple and elegant. Unfortunately, many retirees will be bringing multiple tax silos into retirement. You mentioned the three biggies: the traditional tax-deferred, Roth, and taxable assets. Ideally, you would get some tax advice on which assets to spend first in retirement and which to leave until later. A general framework is that taxable accounts would go first in the queue and that Roth assets would be in the save-for-later bin, but you probably don’t want to just mow them down sequentially, either. So, you would kind of overlay the Bucket structure across your different tax silos. If your taxable accounts were in your spend-first queue, they would most likely be more heavy on safer assets. They would hold more in Bucket 1 and Bucket 2 because you would be operating with the assumption that those would go in your spend-first queue.

How Often Should Retirees Be Performing Bucket Maintenance?

Giles: OK. To wrap up, how often do retirees need to be performing bucket maintenance? Is there a best practice?

Benz: I think once a year is adequate for most retirees. You probably have other things that you want to do in retirement besides managing these buckets on an ongoing basis, but a good once-a-year portfolio review where you take a look at how your various portfolio constituents have performed. You do perhaps a little bit of tax management if you’re subject to required minimum distributions, or you want to take tax losses, you would look at those sorts of considerations. You may bring charitable giving into the equation as well, and you might source which buckets you’d want to pull from for charitable giving. So, I think a once-a-year thorough annual review and bucket maintenance system is plenty for most retirees. And you’d also want to be looking at whether that cash bucket, if you’ve spent from it, needs to be replenished. That would be woven into part of that maintenance regimen as well.

Giles: All right. Well, that certainly feels doable. Christine, thanks for taking the time.

Benz: Thanks so much, Margaret.

Giles: I’m Margaret Giles with Morningstar. Thanks for watching.

Watch The Types of Bonds That Your Portfolio May Need—and the Bond Types It Can Do Without for more from Christine Benz.