With life expectancies rising and retirement periods lengthening, having an effective retirement investment strategy is crucial for financial security in later years. The two-bucket approach is one of the most straightforward yet powerful strategies to generate retirement income while preserving capital. By segmenting assets into distinct ‘buckets’ for near-term withdrawals and long-term growth, retirees can sustainably fund living expenses while still achieving portfolio growth over time. When implemented properly, the two-bucket system helps mitigate sequence of return risk, provides inflation-protected income, and brings greater certainty to uncertain retirement landscapes.
Allocating assets to short-term and long-term buckets
The two-bucket retirement strategy entails dividing assets into a ‘near-term’ bucket and a ‘long-term’ bucket. The near-term bucket holds enough cash and very low-risk assets to cover living expenses for 2-5 years. Withdrawals are made from this bucket first in retirement. The long-term bucket contains the balance of assets invested more aggressively for growth. This bucket is left untouched in the early years. This approach reduces the need to sell riskier assets when markets decline. The near-term bucket also creates a margin of safety so the long-term bucket can remain invested for higher returns. Bucket allocations depend on personal spending needs and risk profiles. More affluent retirees with greater cushions may allocate 50-70% to short-term assets, while less affluent retirees may need closer to 70-90% in the near-term bucket.
Funding the near-term bucket with cash and low-risk assets
The near-term bucket should provide a stable source of cash flow to pay bills and expenses in the early years of retirement before tapping growth assets. This bucket is typically filled with cash, money market funds, high-quality short-term bonds, CDs, and other highly liquid securities. Annuities and bond ladders may also generate reliable income. The focus is on principal preservation and liquidity rather than growth. Low-risk assets reduce volatility and provide stability during major market swings. This minimizes the need to sell equities after declines. Withdrawals can be made systematically based on annual spending budgets. Near-term buckets should be replenished with fresh income sources as balances decline.
Investing the long-term bucket for growth
While the near-term bucket covers current income needs, the long-term bucket is invested for growth to replenish the income bucket over time. This bucket contains more aggressive investments like stocks, alternative assets, and diversified equity funds. Long-term capital appreciation is the priority. With a sizable near-term bucket as a buffer, the long-term portfolio can remain invested through market swings. This enables retirees to maintain exposure to stocks and growth-oriented assets that tend to outperform over extended periods. Rebalancing between buckets may be required every few years to restore target allocations as the near-term bucket is drawn down. The long-term bucket essentially re-funds the near-term bucket.
Sequencing withdrawals from near-term and long-term buckets
The two-bucket system creates a sequenced withdrawal order that protects long-term assets in the early retirement years. The initial sequence goes as follows: Year 1) Withdraw cash flow needs from near-term bucket only. Long-term bucket remains untouched. Year 2-5) Continue pulling cash flow needs from near-term bucket. Replenish if balances get low. Year 6) Withdraw any cash flow shortfalls from long-term bucket if near-term bucket is depleted. Rebalance buckets back to target allocations. Sequence repeats in later retirement years. This sequenced approach preserves growth assets so they can keep generating returns over long horizons and re-fill the near-term bucket over time through rebalancing.
The two-bucket retirement investment strategy offers an intuitive yet tactically sound approach for generating sustainable retirement income. Segmenting assets into separate pools helps retirees balance present income needs with long-term growth. Systematically sequencing withdrawals from each bucket also mitigates exposure to sequence of return risk. Proper implementation requires determining appropriate asset allocations for each bucket, choosing suitable investments, having a disciplined rebalancing schedule, and utilizing cash flows efficiently. The two-bucket method brings clarity and flexibility to retirement distributions.