The bucket strategy in retirement has a seductive appeal. But whenever I read proponent’s explanations I come away totally underwhelmed. There is almost always a lack of rigor and analysis that I’ve come to expect as a minimum bar.
A recent blog post on The Retirement Manifesto is a typical example of the genre.
How to Build A Retirement Paycheck From Your Investments - The Retirement Manifesto
For decades, you've been diligently saving and building your nest egg to insure you'll have a shot at maintaining an…
Let me walk through what a real retiree would face using this bucket strategy.
You’ve just retired. You have $1,000,000. Following this article, you have $120,000 (three years of expenses) in your Cash Bucket; $320,000 in your Income Bucket; and $560,000 in your Long Term Growth bucket. That gives you a 56/44 asset allocation which is reasonable.
You retire on January 1, 2013. You set things up for that every month, $3,333 gets transferred to your checking account from the Cash Bucket. That covers your $40,000 a year in expenses.
You’ve set things up so that dividends from the Income Bucket and Long Term Growth Bucket both go to the Cash Bucket, the “Drip Refill” method.
Every quarter you check on things. This is how it looks in early April 2013, three months into your retirement.
- You’ve withdrawn $10,000 from the Cash Bucket to pay for expenses.
- Your Income Bucket has had $2,397 of dividends.
- Your Long Term Growth Bucket has had $2,659 of dividends.
- Your Cash Bucket is down to $115,057, which is 2.87 years of expenses.
Refilling the Buckets
You said the Cash Bucket was going to hold 3 years of expenses. That way if a major recession hits you can last for 3 years. You no longer have 3 years of expenses in the Cash Bucket.
Do you refill it?
This has been a totally normal market. The Cash Bucket is to protect you from big market drops, right? So you should refill it.
Several times per year (I’ll target quarter-ends) look for any asset class which has performed well, and sell portions of those investments to refill the cash in Bucket One.
Your Income Bucket was at 83.90 a share in January; it is now at 83.41 a share. Nothing has “performed well” — it is down — so you don’t sell anything to refill the Cash Bucket.
So what do you sell to refill the Cash Bucket?
The Long Term Growth Bucket? But we already said “you shouldn’t have to tap the money in Bucket Three for ~10 years.” Why are we talking about tapping that three months into retirement?
It seems like we have three options:
- Don’t refill the Cash Bucket (yet). After all, it is only down a little bit. And we did have a 1–3 year range. We’re still within that even if we’re not at the target we set a mere 3 months ago.
- Sell from the Income Bucket even though nothing is up.
- Sell from the Long Term Growth Bucket even though it has only been three months and not 10 years.
Here’s how those would play out over the rest of 2013.
Option 1: Don’t refill the Cash Bucket (yet)
You do nothing. That’s always easy.
Three months later, July 2013, you check in on things again.
- You’ve taken another $10,000 out of the Cash Bucket for your expenses.
- You only got $1,882 of dividends from the Income Bucket.
- You got $3,217 of dividends from the Long Term Growth Bucket, which was more than last time.
- Your Cash Bucket is down to $110,156. That’s 2.75 years of expenses.
You’re in the same situation you were before. Nothing has appreciated in price in your Income Bucket. (Actually, nothing will appreciate in price until July 2016, so you’ve got a bit of wait.) You have the same three choices. Let’s say you keep riding it for the rest of the year.
Now it is January 2014.
- You spent another $20,000 over the past 6 months.
- You received $4,222 in dividends from your Income Bucket.
- You received $6,970 in dividends from your Long Term Growth Bucket.
- Your Cash Bucket is down to $101,350, which is 2.53 years of expenses.
Except…you need to adjust your withdrawals every year for inflation. You look up CPI and find out that you need to take out $40,648 this year. So your Cash Bucket is actually down to 2.49 years of expenses.
Good thing inflation was low! Only 1.62%. Imagine if it was closer the long-term average of 3.5%. Or, god forbid, the high inflation of the late 70s and early 80s. If this were 1980–1981, when inflation was over 10%, then your Cash Bucket wouldn’t cover 2.53 years of expenses right now, it would only cover 2.3 years of expenses.
And that’s after a single year.
You’re faced with the situation you faced after the first quarter. Do you sell from your Income Bucket even though nothing has appreciated in price? Do you sell from your Long Term Growth Bucket even though it has only been a year?
To add insult to injury, you started the year with a 56/44 asset allocation and now you’re at 63/37.
Option 2: Sell from Income Bucket
Let’s say you opted to refill the Cash Bucket by selling from the Income Bucket. Even though nothing has appreciated in price. Even though you know that it means you’ll be getting less income from the Income Bucket in the future.
It is April 2013, three months into retirement. Your Cash Bucket is at $115,000. It is supposed to be at $120,000. So you sell $5,000 from your Income Bucket. That’s only 60 shares. Next quarter, though, instead of receiving $1,882 in dividends from your Income Bucket you’ll only receive $1,852. That’s only a $30 drop, right?
But, hey, you didn’t tap your Long Term Growth Bucket and your Cash Bucket is back to the 3-year buffer you intended.
Now it is July 2013.
- You spent $10,000 on expenses.
- You received $1,852 from your Income Bucket.
- You received $3,217 from your Long Term Growth Bucket.
- Your Cash Bucket back down to $115,161.
Nothing in your Income Bucket has appreciated but you’re still going to sell something to refill the Cash Bucket. Looks like you need another $5,000; this time that’s 62 shares.
You sell 62 shares. Now you’re only going to receive $1,881 versus the $1,943 you would have received if you hadn’t sold anything from your Income Bucket.
Oh, and your asset allocation is still 63/37 — off from the 56/44 you started at.
Option 3: Sell your Long Term Growth Fund after 3 months
All of this was during a super-simple, nothing-interesting-happened period in 2013 with extremely low inflation. I didn’t cherry pick some Worst Case Scenario for Buckets. Most of the time, your Income Bucket won’t appreciate; after all it holds boring old bonds, those just don’t rocket up continually. Most of the time, your dividends alone won’t be enough to cover your expenses, especially over the years as inflation forces you to increase your withdrawals.
None of the above is exactly impossible to solve.
You could be totally fine selling your Income Bucket for the first decade of retirement, ending up at 100% stocks when you are 75-years old. That’s a viable strategy.
You could not refill the Cash Bucket. Say it is just for the first 2–3 years of retirement to try to ameliorate any bear markets at the start of retirement.
You could tap your Long Term Growth Fund much sooner than a decade from now.
There could be some complicated formula that allows selling your Long Term Growth Fund in flat markets or slowly rising markets but not big bear markets. It would need to cover when you stop selling and when can you can resume selling.
There are all kinds of possibilities. (Not all of which are necessarily good ideas.)
But the nearly universal failure of bucket proponents to outline how it works in real world cases does not inspire a lot of confidence.
Notes: The Income Bucket is assumed to be the BND etf. The Long Term Growth Bucket is assumed to be the SPY etf. Prices are from Google Finance. Dividends are from nasdaq.com.