BY: DAVID RUSSELL, CFP®, CSA®
Vice President & Trust Officer | (601) 707-0008
The recent volatility in the equity and fixed income markets caused by the conflict in Ukraine serves as another reminder of the importance of making sure your retirement portfolio is properly diversified to achieve your current and future needs.
During periods of market declines – like we witnessed throughout the first two months of 2022 – most people tend to become overly concerned about their financial future and want to make changes – and that urge increases when current events add another layer of uncertainty. But one thing is certain: market volatility is beyond your control. That is why it is essential to have in place a proper asset allocation strategy for the stocks, bonds and other investments you own that is tailored to your stage in life.
When managing a retirement portfolio, I like to use the “bucket system” system of investing. Not to be confused with a bucket list (you know, a list of things you want to do before you die), the bucket system of investing categorizes your wealth – and the income that is forecast to be generated – into five buckets, each with its own set of requirements. The system works for any age group, but I find that retired clients like the system best because it allows them to look objectively at their wealth and temporarily forget about current events. In simplistic terms, each of the buckets can be described as follows:
1| The Income Now Bucket: As its name implies, this bucket identifies the income required to maintain your current lifestyle for the next two-to-five years. Assets placed in this bucket should be as risk-free as possible and limited in scope by the liquidity and safety requirements imposed by this bucket. If income from a pension or social security (or both) is sufficient to fund your needs, this bucket may only contain a cash reserve fund. If there is a gap, then immediate annuities or short-term municipal bonds or bond funds can be used. Due to interest rate risk, longer-term bonds or CDs with maturities longer than five years should be avoided.
2| The Income Later Bucket: This bucket identifies the income you need further down the road – perhaps five or more years from now. The assets placed in this bucket and investment options vary widely depending on several factors, such as your risk tolerance or preference for dividend income. Your financial advisor can calculate an amount that should be allocated to this bucket and provide reasonable assurances that by the time this bucket is needed there will be sufficient funds available.
Over time, some or all the assets in this bucket are poured into the “Income Now” bucket and managed according to that bucket’s requirements. During this stage of life, you should set aside funds for some form of long-term care, either for facility care or home health care. If you have long term-care insurance, then the net cost above what the insurance pays needs to be factored in. Tax-deferred annuities, laddered bonds or dividend-paying stocks, mutual funds or exchange-traded funds may be appropriate investment vehicles.
3| The Lump Sum Now Bucket: This bucket identifies your lump sum financial needs for the next three years, such as paying off a mortgage or prepayments to a long-term care facility. Cash equivalents such as CDs, short-term treasuries or ultra-short bond funds can be used for this bucket.
4| The Lump Sum Later Bucket: Retired individuals or couples may face lump sum requirements down the road (in five or more years, for example). These are known future obligations, such as a balloon mortgage payment, upfront costs to a retirement community or a business buyout obligation. If these future requirements are fixed amounts, investments with a low risk of principal loss should be considered, such as tax-deferred annuities, zero coupon bonds or short-term corporate and government bonds. Longer-term obligations that are less critical can be funded with an appropriate mix of equity and fixed income securities.
5| The Surplus Bucket: Here’s where it gets a little more fun, because at this point all of your known current and future obligations have been accounted for and funded in the appropriate bucket. The “Surplus” bucket includes whatever is left and can be used for either short- or long-term items such as funding a grandchild’s education, leaving a charitable legacy or making gifts to children. Risk is often less of a concern here because you are certain that your required needs have been funded.
The bucket system requires careful planning and active management to ensure that investments are allocated properly. It is important to understand that it is not a “set-it-and-forget-it” strategy because the buckets must be adjusted as you age. Nevertheless, we find that clients weather volatile markets better knowing that their wealth is not affected by current events and that they will have enough income to enjoy their life now and in the future.
If you would like to learn more about managing your retirement portfolio and the bucket list strategy, please contact one of our financial advisors. We are ready to help.