Bucket Investment Strategy: The Importance of a Strong Bucket #1

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By Scott Keegan, Associate Wealth Advisor

When it comes to retirement income, there are many different techniques and strategies you can employ. In a previous blog, Managing Market Corrections & Retirement Income, Senior Wealth Advisor Mike Gertsema laid out our philosophy of bucketing and how it can be used to produce income while also allowing a portfolio to participate in growth in the markets.

According to the RIMES data company, the Standard & Poor’s 500 Composite Index (S&P 500) from 1948-2017 has experienced a 20% or more correction about once every 6.3 years. Assuming a 25-year retirement, that would mean nearly four 20% or more drops in the stock market over the course of a client’s retirement.

When someone is in their early working years and regularly saving in their 401(k), a 20% drop in the stock market probably means little to nothing to them, other than they are buying stocks on sale through retirement savings contributions. To someone who is in or near retirement, a large drop in the stock market can be very emotional and cause a real risk to their retirement income sources and standard of living.

If structured correctly, bucketing can be an effective tool to help insulate a portfolio from market corrections. Each of the three buckets has a distinct and specific purpose in the portfolio. Bucket #1’s job is simple: don’t lose money. ]

Bucket #1’s Job

In this model, Bucket #1 is where 100% of distributions or planned expenditures come from. We invest this bucket in capital preservation and irreplaceable capital investments to minimize the risk of the overall portfolio. Typically, these investments are comprised of short-term bonds.

By pulling money from this very conservative bucket, the risk of taking money out of the market at the wrong time is greatly reduced and allows the Bucket #2 and Bucket #3 to stay invested until the markets recover.

According to RIMES, the S&P 500 on average takes 425 days (or 1.5 years) to recover from a 20% or more drop. Using this information, we always ensure we have at least two years’ worth of expenses in Bucket #1. Having two years of expenses invested in capital preservation increases the odds we don’t need to dip into any other buckets when we see a large market correction.

Essentially, this gives our clients “staying power,” meaning when the market heads south and panic heads north, our clients have the plan and ability to ride out the waves of the markets knowing they aren’t selling any of their growth investments at a loss. Rather, they can stay invested and wait for the market to come back before making any allocation changes.

Bucket #1 After the Storm

Once the storm is weathered and Buckets #2 and #3 have come back up, we simply take profits and fill Bucket #1 to help ensure we can ride out the next storm. In great markets, Bucket #1 is the bucket we are apologizing for having in the portfolio; in bad markets, it can be our saving grace.

Bucketing can be an extremely effective tool for anyone in or nearing retirement, provided the proper planning is done to make a strategy that will work for the client. To know how to structure the buckets and the amount to have in each bucket, a full financial plan is necessary to create a portfolio to get someone to and through retirement.

Stay tuned for my commentaries on Buckets #2 and #3 in upcoming blog posts!

Schedule a no-obligation conversation to discuss what your buckets should look like.

 

This piece is not intended to provide specific professional advice. To determine what is appropriate for you, consult a qualified professional. All investing involves risk, including the possible loss of principal. There is no assurance that any investment strategy will be successful.

S&P 500 – A capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

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