Monday, July 16, 2012

The Bucket Approach for Retirement Income

Sand bucket on the beach of Punta del Este, Ur... (Photo credit: Wikipedia)
For many people the worst part of investing is short term volatility of the market. Going through that stomach turning rollercoaster can keep you up at night. You worry if you are going to have enough money to cover daily expenses. Staying invested during these trying times is very hard to do if you are worried about your life savings going down everyday. 

The solution is to find a way to keep you afloat during these frightful time. You need to find a way to insulate yourself from the storm until your through it. The "Bucket Approach" is a possible way to help you through these tough times.

Harold Evensky, President of Evensky & Katz Wealth Management, has come up with the "Bucket Approach" as a strategy for solving this problem. Back in the eighties Harold developed this approach which includes his five-year mantra. It simply means do not invest money you are going to use within 5 years.

His plan says to carve out a lump sum that you will be needing, short term. These needs can be a second home you may want to purchase in 3 years. You take that chunk of money and put it in short-term bonds or cash. Also, that goes for your retirement money that you need to live on for the next five years. But in this instance, you would be losing to much in potential growth so through experience Harold says to only take out two years worth of living expenses. The rest of your retirement money stays in your total return portfolio.

What you do is take that cash and set it up to pay yourself a check once a month like a payroll check. The market can be volatile, but you know where your grocery money is coming from, so you are not going to be panicked when the market is going down. As you manage your investment portfolio you need to rebalance as necessary.

This helps you be much more cost and tax efficient in managing that portfolio. You are not going to have to sell at the wrong time. You can sleep through volatile times. Your worry level should be way down during the tough times. Your portfolio may be down but you have money to live on for two years. This relieves any need to sell off your investments at the wrong time.

How Many Buckets Do You Need?

The amount of buckets you need can be as many goals you need to finance within a five year period. But for the small investor two buckets will do. One bucket with two years of expenses and the other holding your retirement portfolio. The most important thing is you have your short term cash in a bucket available to spend. Having other buckets for a trip or college expense, or a car is also good to do if you have the funds available. There is no reasonable limit to how many buckets you can have. 

The problem with multiple buckets is there more to keep track of but you are in a more organized position. Plus you are able to borrow and move around cash between buckets as you see fit. This system gives more control over your finances

My Take.

I believe this plan can work and solve the number one problem of retirement investors which is selling at the low. It would of worked in the last deep decline. You would of been able to hold on till the market began to rise again. I can imagine the freedom having two years of expenses put aside. Not having to worry about paying the bills and knowing you are able to ride out the storm. What's your take?

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