Manage market risk in retirement with the bucket strategy

For many people who are retired or nearing retirement, it can be challenging to figure out how to draw down their savings without running out of money. And that makes sense—for so long, you work toward saving money. Spending it without overspending takes intention and strategy.

One effective approach is the retirement bucket strategy. It provides funds for immediate expenses while preserving your nest egg for long-term growth and future income needs. Here's what you should know about this financial strategy and if it's right for you.

With the retirement bucket strategy, you separate your nest egg into short-, medium- and long-term buckets. You invest near-term savings in safe assets to pay for daily expenses, while the other buckets are invested more aggressively and used to replenish the near-term bucket as needed.

Other retirement income strategies emphasize systematic withdrawals from an entire portfolio, along with optimizing tax efficiency across different account types. The retirement bucket strategy segments your money to provide stability in money you may need today with the ability to grow money you may not need for a while.

The retirement bucket strategy works by divvying up your investments by purpose:

• The short-term bucket is used to cover your spending over a one- to three-year period.
• The medium-term bucket is for money needed in the next four to seven years.
• The long-term bucket is for money you need eight or more years in the future.

You periodically refill your short-term bucket with funds from your medium-term bucket, and replenish the medium-term bucket using assets from the long-term growth bucket. How often you should do this isn't a hard-and-fast rule, but planning to review your buckets (and refill them if needed) annually is a good starting point.

By spreading money across your three buckets, you can gain confidence paying for near-term expenses by accessing funds that are focused on safety, while your other assets remain invested for growth to help support your future needs. During periods of market declines, the money you need today won't be exposed to the market. 

Here’s an overview of which investments you should hold in each bucket:

This money covers near-term retirement expenses for one to three years, supplementing Social Security benefits and pensions and other guaranteed income sources. Because of that, these funds need to be invested in safer cash or cash-equivalent options, such as money market funds or short-term Treasury bills. 

The money invested in this bucket should focus on stability and generating income. Investment options can include bonds and asset allocation funds with a more conservative asset mix. 

The money in this bucket has the longest time horizon. It should hold stocks and other growth assets that will provide you with inflation protection and also generate growth to fund your retirement income needs in your later years. 

If the market experiences a decline toward the end of your working years, or shortly after retiring, you increase the risk of running out of money later in life or reducing the amount of ongoing income. A main benefit of the retirement bucket approach is that your short-term bucket can provide you with living expenses so you can make it through market downturns without having to sell stocks. 

Here's a closer look at the advantages of the retirement bucket strategy:

• Helps retirees avoid selling stocks in downturns. Relying on stock investments for living expenses may force you to sell when values are low. Staying invested, even in periods of volatility, is essential for building and maintaining wealth. Your long-term money remains invested for growth despite market swings. 
• Provides psychological reassurance with cash on hand. It can be difficult to sit tight with your investments when the market is declining. Knowing your short-term needs are covered by money in safer investments can help you resist panic-selling when the market is down. 
• Offers a structured retirement drawdown plan. By withdrawing assets for living expenses from the short-term bucket and replacing those assets with funds from the medium- and long-term buckets, you establish a disciplined, repeatable drawdown strategy that eases the burden of generating retirement income.
• Supports long-term growth while funding near-term needs. Today’s retirees may spend 20 or 30 years in retirement after they leave work. The three-bucket strategy can help you keep a portion of your retirement funds invested for growth in the earlier years of your retirement to support you later in life.

No retirement drawdown strategy is without disadvantages. Understanding the different factors that play a part in an investment strategy can help you determine which one is right for you. The potential drawbacks of the retirement bucket approach include:

• Requires ongoing management and rebalancing. Your income isn’t guaranteed so you may need to regularly rebalance your investments to refill your short-term bucket. Pairing the bucket strategy with guaranteed income sources like Social Security, pensions or annuity income could make ongoing management easier. 
• Risk of underperformance if markets lag. If there is an extended bond or stock market downturn, the value of your investments in both your mid- and long-term buckets could experience significant declines, leaving you with less money to transfer for your short-term needs.
•  May require adjustments for tax efficiency. Different types of investments and retirement accounts are taxed in different ways. This affects what money you should take out and when. Failing to invest and withdraw funds in a tax-efficient way can diminish how much of your money is available for living expenses and future growth. 

Let’s go through the steps to set up a bucket approach to retirement. 

1. Define your retirement timeline. At what age do you plan to retire, and how many years do you expect to live in retirement? 
2. Identify your income needs. What will your fixed costs be in retirement, and what are your sources of income other than retirement savings? Calculate what you expect to receive from Social Security benefits and any pensions. Also consider line items that may change; perhaps you plan to downsize your home, but you expect medical expenses to increase (this is typical for people as they age).
3. Divvy your assets into buckets. Once you determine your annual expenses, divide your money into short-term, mid-term and long-term buckets. 
4. Create a rebalancing schedule. Determine when you’ll revisit your asset allocation and withdrawal plan, adjusting as needed based on market performance and any changes in your expenses and spending needs.
5. Build in flexibility. Market volatility, changes in lifestyle and large purchases may mean you need to adjust your bucket strategy.

Here's an example of what these steps might look like in action:

Michael is 65 years old and about to retire with $750,000 in savings. He expects his money will need to last at least 20 years and that he’ll need to withdraw $30,000 a year from his savings. He puts $100,000 into a money market fund in his short-term bucket to cover three years of living expenses and provide a cushion against unexpected costs. He then allocates $200,000 to his intermediate bucket, investing those funds into dividend-paying stocks and a conservative asset allocation fund that holds a mix of bonds and stocks to generate income and growth. For his long-term bucket, Michael invests his remaining $450,000 into a growth stock fund to capture growth, even as he anticipates the potential for greater volatility. 

The bucket strategy helps retirees cover day-to-day expenses with confidence while maintaining investment growth to support long-term goals and legacy planning. As you think about whether this approach is right for you, consider your anticipated retirement expenses, lifestyle and all income sources. A Thrivent financial advisor can help you calculate your retirement income and expenses, then help you decide if the three-bucket strategy is right for you.