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When you retire, how you put your investment portfolio together is more important than ever if you want your retirement savings to last as long as you do.
Your investments need to not only keep pace with inflation, they also need to grow to pay for your lifestyle and to be protected from investment risk.
Balancing all these competing requirements can be tricky. One solution is a retirement bucket strategy. This approach establishes different ‘buckets’ or accounts for different types of spending and investing over the entire period of your retirement.
For more information, read SuperGuide articles The 10/30/60 rule: What it is, and how it can help your retirement plans and 9 investment risks and how they can affect your super.
What’s a bucket strategy?
The bucket approach to managing retirement portfolios was pioneered by US financial planning guru Harold Evensky in 1985.
Bucket strategies are designed to balance the need for income stability and capital growth in retirement. The aim is to make your money last, while still giving you the flexibility to make a lump sum withdrawal for expenses like holidays or home renovations.
Although there are several ways to use the bucket concept, the most common is a three-bucket strategy.
The approach is popular with many retirees because it eliminates the risk of having to sell your investments when the market is down to pay for regular living expenses. Its popularity has seen some industry super funds begin offering super pensions based on the strategy.
How does the strategy work?
The bucket approach divides your retirement into different phases, with a separate account established to meet your financial needs as you age.
A three-bucket retirement strategy, for example, divides your retirement savings into three accounts (short, medium and long-term), each of which has a different role:
1. Short-term bucket
2. Medium-term bucket
3. Long-term bucket
Once the bucket strategy is operational, the only bucket with automatic withdrawals is bucket 1. The other two buckets are adjusted manually – often annually – with funds from bucket 3 refilling bucket 2 and bucket 2 refilling bucket 1.
How your retirement buckets are invested
Each of your retirement buckets has a different time horizon, objective and asset allocation:
|Bucket||Time period||Investment goal||Asset allocation|
Bucket 1 is designed to fund your short-term living expenses, so it’s invested in assets that do not fluctuate with the market (like cash), as you need this money to live on and pay your fixed expenses. Your cash bucket provides peace of mind you can pay your bills and ride out the normal ups and downs affecting your longer-term investments.
The other buckets contain assets that won’t be needed for several years or more, so they are invested in diversified strategies designed to deliver both medium and long-term objectives.
Case study – Three bucket retirement strategy using a pension from your super fund
Deepa is aged 67 and has $560,00 in her super account.
When she retired from full-time work in July 2019, Deepa decided to commence a three-bucket pension with her super fund.
She also decided to take the 5% minimum pension payment amount set by the government. As she is 67 years old, this amount is $28,000 a year. For more information, read SuperGuide article Guide to minimum pension payments rules (including calculator).
As a result, Deepa’s pension account balance is invested as follows:
Short-term bucket (covers pension payments for 3 years) 3 x annual minimum pension payment amount3 x $28,000 = $84,000 Medium-term bucket ($560,000 – $84,000) ÷ 2 = $238,000 Long-term bucket ($560,000 – $84,000) ÷ 2 = $238,000
Each of Deepa’s pension buckets is invested using a different investment strategy designed to suit the time period for which she is investing.
Her super fund invests her short-term bucket in its cash investment option, while her medium-term bucket is invested in the fund’s conservative investment option. The money in her long-term bucket is invested in the growth investment option.
Deepa’s super fund rebalances the money in each of her buckets annually to maintain the desired level of money in each bucket. This ensures she always has a minimum of two years of pension payments in her short-term bucket as she moves through retirement.
4 drawbacks to the bucket strategy
Using the bucket strategy to manage your retirement savings is not for everyone. As with any investment strategy, this approach has some issues you need to consider:
1. Establishing the strategy can be complex
There is no definitive or best way to set up a retirement bucket strategy. Opinion varies over whether you should use two or three buckets, while there are also approaches using buckets based on your needs and wants.
Working out the right asset classes and investments to use for each bucket can also be complex.
2. Managing it can be tricky
A bucket strategy is generally not set?and-forget. Maintaining the various accounts and keeping the right amount of money in each bucket can be time consuming.
You also need to establish rules for when and how you will replenish your buckets and what you will do with returns if your investments do better (or worse) than expected.
3. Compatibility with a transition-to-retirement (TTR) strategy
A bucket strategy may not be suitable if you are also using a TTR strategy. As this approach involves withdrawing from your super account while simultaneously salary sacrificing money back in, you are in effect recycling your cashflow.
For more information, see SuperGuide article Guide to transition to retirement pensions (TTRs or TRISs)
4. Unsuitable for conservative retirees
A bucket strategy may not be right for retirees with a conservative risk profile. With historically low interest rates for your cash bucket, you must be prepared to invest in riskier assets in buckets 2 and 3. If not, the strategy may not work as your savings will not be growing enough to replenish your first bucket.
For more information, see SuperGuide article Super investing: What is your risk profile?
Learn more about retirement income in the following SuperGuide articles:
- Retirement cost of living: How much does a comfortable lifestyle cost?
- How much super do I need to retire?
- How to maximise your Age Pension
- How inflation affects your retirement income forecast
- ‘Today’s Dollars’: The impact of inflation on retirement income
- Retirement income in Australia: An overview
- Target retirement income: An explanation of the 66-80% rule of thumb