As retirement approaches, it becomes increasingly important to optimize your investment portfolio to provide stable income while still allowing for growth. The two-bucket investment strategy is one of the most effective approaches for balancing these goals. By dividing your assets into a ‘cash-flow bucket’ and a ‘growth bucket’, you can generate consistent cash flow to cover expenses while also remaining invested for continued capital appreciation. This strategy provides both security and flexibility needed in retirement. In this article, we will explore the key benefits of using a two-bucket system and how to implement it properly based on your personal situation.
Mitigate sequence of returns risk
One of the biggest risks in retirement is sequence of returns risk, which refers to encountering poor market returns early in retirement that can irreparably damage a portfolio’s ability to generate lasting income. By holding several years of cash flow needs in safer assets, the cash-flow bucket helps mitigate this risk. Even if the market declines, you can rely on the cash-flow bucket while giving your growth assets time to recover.
Customize your cash-flow bucket
The cash-flow bucket should be sized to cover at least the next 3-5 years of retirement spending needs. This gives you several years to ride out market turbulence without selling growth assets at a loss. The exact size depends on your risk tolerance and expected longevity. More conservative investors may opt for 10+ years of expenses in cash. Just ensure to hold this bucket in stable assets like cash, CDs, short-term bonds, etc.
Invest for continued growth
With your basic income needs covered, the growth bucket can remain fully invested in stocks, real estate, and other return-seeking assets ideal for long-term growth. This bucket should be diversified globally across equities, bonds, real estate, etc. The growth from this bucket will provide income later in retirement after depleting the cash-flow bucket. Remaining invested is key for combatting inflation.
Rebalance regularly
Revisit your target allocations for each bucket annually and rebalance to maintain the right asset mix. As you withdraw from the cash-flow bucket, replenish it by selling assets from the growth bucket so that the overall allocation stays on track. This helps lock in gains from growth assets and ensures your income buffer stays robust.
Utilizing a two-bucket investment strategy can provide the stability of an income cushion while allowing continued growth on investment capital. This approach is flexible enough to cater to any retirement scenario. By mitigating risk, providing income, and maximizing returns, the two-bucket system optimizes your chances of a comfortable retirement.