Times-Call (Longmont)

Is bucket strategy right for you?

- Dave Gardner

Over the last few years, socalled bucket investment strategies have received increased attention by researcher­s and investors alike. It may be that it could work well for your portfolio. We’ll delve into the definition of bucket strategy and work through an example to see if it may be a good fit for you.

The image of buckets certainly does not evoke a hot, new investment concept. Something as pedestrian as a bucket hardly has the same vibe as a meme stock or nonfungibl­e token. (Remember those?) Simply put, a bucket strategy is a method of dividing up your investment portfolio into different accounts. Each of the different accounts (or buckets if you will), has a different purpose or goal associated with it.

Splitting your investment­s between different accounts is nothing new. After all, many of us have investment­s that are pre-tax (such as a traditiona­l 401(k) or IRA), tax-free (such as a Roth), and taxable (such as a savings account or taxable investment account).

The bucket strategy is more about the purpose of a given account rather than the actual type of account. This is perhaps best illustrate­d with an example. Let’s imagine Rick (aged 65 years old) is about to retire after a long career. He has $600,000 in his 401(k) at work. He hasn’t paid too much attention to it before now, other than choosing a target retirement fund as an investment and regularly contributi­ng to it every year through work, along with an employer match.

But now that he’s about to retire, he’s wondering how he is going to take his 401(k) balance and make it into a series of monthly payments that will continue the rest of his life. This latest market decline has him spooked as it’s the second bear market in the last three years. While he was fine ignoring the markets as he was putting money into the 401(k), he now looks to withdraw from his retirement plan and the recent volatility leaves him uneasy to say the least.

Rick plans to wait until age 70 to take Social Security, as his benefit will grow 8% a year from his normal retirement age until the maximum benefit is reached. But he needs a way to bridge the income gap between now and when his Social Security benefit of $3,000 a month starts. Rick can roll his funds from a 401(k) directly into a traditiona­l IRA with no tax consequenc­e once he retires. While there may be advantages to leaving his assets there, having a traditiona­l IRA that can be held at a custodian, like Schwab, Fidelity, or Vanguard, could give him a greater ability to select the investment­s that are best suited for him.

Rick sets up an IRA account at his favorite custodian for bucket number one, let’s call it the short-term bucket. This will be used to help him pay his bills over the next three years or so. He doesn’t want a lot of volatility in this account since it will be his income while he’s waiting for Social Security. In this IRA account he moves $126,000 from his 401(k), which is equal to $3,500 a month for the next 36 months.

Once this IRA is funded, he purchases Treasury bills or a money market fund with one third of the account to fund regular withdrawal­s of $3,500 a month over the next year. With the remainder of his short-term bucket IRA, he purchases a Treasury bond that matures one year from now, and another that matures two years from now. He could also use ETFS and mutual

funds to achieve the same strategy.

Rick is planning on $3,500 a month withdrawal­s from his IRA because he will be withholdin­g federal and state income tax on the distributi­ons. These withdrawal­s are taxable as ordinary income, although there are some nice tax breaks for certain state taxes. Once these taxes are withheld, he’s left with $3,000 a month going into his checking account.

The remainder of the 401(k) is put into a second IRA as the investment bucket. Rick invests this account in a 60% stock and 40% bond portfolio using the ETFS or mutual funds of his choice. This account will be more volatile, and Rick will need to be prepared for a portfolio like this could decline up to 30% in a horrible bear market, such as the Global Financial Crisis of 20082009. In return for taking more risk, Rick’s expectatio­n is that he will see higher potential growth in this bucket over time than the short-term one.

Astute readers will recognize that the short-term bucket will gradually decrease as you take distributi­ons to fund your living expenses. To address that, every year Rick will transfer another $42,000 from the investment bucket IRA into the short-term bucket IRA. Once those funds are moved into the short-term bucket, he will use those funds to purchase another Treasury bond that matures in two years. He will repeat this process every year at least until his maximum Social Security benefit kicks in.

As you might imagine, there are many ways to implement the bucket strategy and solve additional complexiti­es once you introduce different types of accounts, a spouse, pensions, and other considerat­ions. This example provides a taste of a bucket strategy. Speak with a qualified financial profession­al to see if this is an option that could provide financial independen­ce as you become reliant on your investment­s to fund your retirement spending.

David Gardner is a Certified Financial Planner profession­al at Mercer Advisors practicing in Boulder County. The opinions expressed by the author are his own and are not intended to serve as specific financial, accounting, or tax advice. They reflect the judgment of the author as of the date of publicatio­n and are subject to change. The informatio­n is believed to be accurate but is not guaranteed or warranted by Mercer Advisors. Content, research, tools, and stock or option symbols are for educationa­l and illustrati­ve purposes only and do not imply a recommenda­tion or solicitati­on to buy or sell a particular security or to engage in any particular investment strategy. This presentati­on is not a substitute for a client-specific suitabilit­y analysis.

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