The 3 Buckets Strategy of Retirement Planning
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Not all retirement withdrawal strategies are created equal. And that makes perfect sense because not every retiree's goals are the same.
Some people are retiring well into their 70s, they realize that they likely don't have many years left to go and they're not too worried about outliving their money. They just want to enjoy life to the fullest for the time they have left. For those people, more dynamic withdrawal strategies such as the 1/N method may be a viable option to fit their needs and goals.
Other retirees are retiring at a more normal age or perhaps slightly early and expect to be needing to withdraw from their nest egg for 20 or 30 years. These people may have a little bit more concern when it comes to outliving their money, but in comparison to a bare-bones early retiree, maybe not so concerned that they would be willing to forgo too many of the lifestyle perks that they have become accustomed to over the years. As such many of these retirees may want to adopt a more moderate to conservative withdrawal strategy.
Still, others are retiring incredibly early or just wish to leave a lot of money to their heirs or to a charity or cause when they pass on. For these individuals, a truly conservative strategy may be in order.
As you can tell in today's video we are going to be continuing our series on retirement withdrawal strategies. Today we're going to be covering a strategy called the three buckets of retirement withdrawals. As always we're going to be going over what the three buckets strategy is, why we would use it, who it would work well for, and, of course, it's pros and cons in comparison to other popular strategies.
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I use the 2 bucket system. 4 years of cash and everything else into Vanguard Wellington. When the market is up I take it out of Wellington and when it is down I take it out of cash. I like keeping it simple
I've seen other explanations of the 3 bucket strategy where the 3rd bucket is invested in dividend-paying stocks. There is, for example, a Vanguard high-dividend stock that pay 2.8%. So that $520K bucket, in this example, would produce $14,560. Both Buckets 2 and 3 are used to replenish Bucket 1.
The example starting at 6:10 misrepresents the 4% Rule. The original 4% Rule (as Bengen described it) requires that you have 40% in fixed income and 60% in equities, and it does NOT specify where to pull the money from. So if the stock market drops 50% in first year, a retiree would pull from the fixed income portion. ANd because the 4% Rule require rebalancing, there is a need to use the Fixed Income portion of the portfolio to buy equities so that the portfolio is back to 60/40. This is exactly what you would want - buy equities when they are low.
Thank you for this video.
I think it needs a fourth bucket for safe income securities that are highly liquid, and then when the stock drops 50% the fourth bucket can be liquidated and used to buy stock at the low price (and then money rebalanced back into the fourth bucket securities from the stock after it recovers).
The problem with the bucket strategy is..that though in downturns it will limit losses to overall retirement corpus. In bullmarkets, it will severely limit upside growth aswell
It won’t be severe depending on the size of each bucket.
In retirement capital preservation is more important than large growth
😊excelente video, muchas gracias, por ponerles subtitulos en español. Saludos.
If you are retired, about 50/50 allocation is a good start (Moderate allocation) and that includes T-Bills, Intermediate Bonds, and your money market fund. And a mix of AVGE, FDIF, and MAGS for your equity exposure and Worldwide coverage. You can pick between MAGS and FDIF if you want to avoid duplicate company coverage; however, both of these ETFs cover AI, go with FDIF which is a fund of funds ETF of "DISRUPTOR" companies in five sector ETFs in the stock market. You can also add the GLTR to add precious metals to your portfolio. I have four buckets with the fourth being a taxable account for my RMD withdrawals.
Thanks
Welcome!
In this example, since Bucket 2 is being depleted annually to fill Bucket 1, when is Bucket 3 used to replenish Bucket 2?
Do dividends earned from a taxable account count towards the earned income limit in a Roth IRA?
Dividend income is not considered to be a form of compensation or earned income and doesn't count towards the contribution limit when investing in a Roth IRA.
Buckets 1 & 2 = Series I Savings Bonds for me right now :) Bucket 3 is VTI/ITOT :) 9.62% return rate right now on I-Bonds.. insane :)
Great video!!
I am going with a two-bucket system, but modified. I will have 3 years worth of expenses in cash/CDs. I have never cared for bonds so I will only own those in growth and income mutual funds. I am invested in a variety of investment vehicles as well. I am putting a portion of my nest egg into products with a guaranteed lifetime income since my life expectancy is 95. I have a portion in mutual funds and am now looking into stocks for the future.
Why not 4% rule from 60/30/10 (stock/bond/cash or gold) $1 million portfolio but withdraw 4% from only bond and cash during bear mkt then rebalance back to 60/30/10 when mkt recovers? That would be 3 buckets strategy using 4% rule so best of both world?
You are not describing the 4% rule correctly. Using the 4% rule you withdraw a maximum of 4% of your total investment balance, yearly. Every year you need to recalculate what 4% of your balance is and that is what you pull out at maximum. You don't just blindly stick with whatever you calculated at the start and go with it as you described. That would be just idiotic. If your investments go down then you pull 4% of that lower balance. This may mean you have to get a part time job. If you are not okay with the idea of this then you would need to save more so you are pulling well below 4% to give yourself some breathing room. There is no need to add for inflation as your balance will naturally go up over time and along with it, your 4% yearly withdrawal.
You don't have an understanding of it yourself. The idea of a 4% rule is to give the person a fixed income of 4% every year from their stock portfolio, this return is then adjusted for inflation, which would be about 2% in the US, to adjust your stock income for inflation and protect purchasing power. This is the the basic idea of the 4% rule by Bengan.
Besides this there are many modifications suggested, eg. Forgoing the inflation adjusted hike in withdrawal during a market crash, or maybe decreasing the 4% withdrawal to maybe 3.5% for the duration of a recession or bear market.
I have never once heard of anyone withdrawing 4% of their yearly portfolio corpus. That would defeat all purposes. If the market crashed 50% then 4% of the new portfolio value would be a miserable half of 4% of the original portfolio value, and you will starve to death. If the market rises 50% percent, the withdrawing 4% of the increased portfolio value would lead to overspending and would not allow for portfolio growth.
Please read about the 4% rule again. You seemed very confused.
At 11:10 of the video. Why don’t John and Jane make anything from SSA? Is this because of early retirement? How do you live on 40k/year?
I could easily live on less than $40k if I were retired.
Probably the best system is the modern portfolio theory. But common folks can't manage it and I worry that most managers can't either. I think the bucket system is the best for common folks managing their own assets.
Fidelity suggests a 1-5% allocation in Bitcoin. What do you think about that?
Hell no!
What makes you say that?
Have you done your research on it or are you just very adamantly against it?
@@pstratt1294 that went well...
Most American families retire with 1/2 of one bucket.
Or still looking for buckets
New cars lol.
I don't think I'll ever buy a new car, just fix my shit.
Would it make sense to apply the 3 buckets strategy to a completely different scenario such as this (not particularly about retirement): 25-year-old with zero debt, and no other savings, inherits $38,000. No immediate purchases planned. Live in SF Bay area where housing costs are outrageously high. Would like to be able to afford own apartment within the next few years(currently rent hacking) and be able to afford to buy a house in 10 years. Funded ROTH to max this year and plan to do so in upcoming years. Would love advice on what to do with the $38K.
I suggest putting it in S&P Vanguard index fund and let it ride. The is a reasonable long term investment.
The alternative is to join with a couple of friends and buy in the East Bay where prices are lower. Perhaps using one bedroom to rent out via Airbnb. My Airbnb income is equal to most of my mortgage.
By the way never sell any house you buy. When you move out rent it out. Once it is paid off it becomes income for retirement.
Keep learning and exploring.
Excellent. This is in my top 10 of financial videos. Thanks.
Glad you liked it!
There’s an additional tax motivation for using 3 buckets. The income bucket is clearly a brokerage account, while the long term bucket is tax advantages accounts which include traditional & Roth vehicles. One can legally manipulate their taxable income depending on what the markets doing & factors like social security, RMD’s, & pensions kicking in.
So if I use a 2% cash back credit card (I pay it off every 2 weeks) for the majority of my expenses, doesn't that mean I'm helping myself mitigate inflation? Lol just thought about that 😁
if you spend 40K at 2% on credit card its only $800 a year.
@@rudistorm3348 yes and if you take that $800 and invest it and earn 7% a year for 20 years it's worth a lot
Or just save the money and invest it straight off....
@@rudistorm3348 $800 is a lot more than $0 and then I invest the $800 which compounds over time. So in 10 years it becomes nearly $12k from only $8k invested.
@@cindyhenry1410 Just save the money on normal recurring expenses? Electric bill, insurances (car, home, life), groceries, gas, pretty much everything but my mortgage. Yes one might be able to reduce expenses (which I've also done), but eliminating spending as a whole is pretty much impossible while living in a modern society, so I may as well benefit from the money I do have to spend.
I was going to go with no middle bucket. But this strategy looks good too.
I'd just once, like to hear how to invest your money once you retire, hopefully without losing any principal.
If you want to be guaranteed to maintain principal, keep it in the bank & lose to inflation. Some growth is necessary to not run out of money. There’s always some risk to get rewarded. The most common approach is to allocate the majority of your funds to reasonably stable income/value investments (think dividend producers) and a smaller portion in growth investments (appreciating stocks). The old 60/40 is about putting 40% in “safe” stuff like bonds to protect against loss without growing & 60% in stocks that mostly generate income but some for growth. This is an antiquated approach due to what bonds are doing with interest rates going up, but I share it to provide an illustration of how many think of the issue.
if i can make a seemingly obvious point, the cash bucket can also make money from CDs
It certainly can! My dad actually had rotating CDs for a while. He had three different three-month CDs that would each come due in a different month so that every month he would have an income 😉
@@NextLevelLife was this back when CDs had a higher yield? I had thought of that strategy back then.
Where would student loans fall in terms of bucket placement
In the “shoulda been payed off long before retirement “ bucket
Definite payments due from one ....additional payments from 2 and three .....as early as possible
What if you have less money on the second bucket, and when the 3rd bucket produces money, you take a bit to replenish the 1st qnd 2nd buckets?
Did I miss something? Wouldn't the first bucket be gone at the end of the 4 years? If so, there is only a 10K improvement over the 4% example.
If I understand correctly ... the 1st bucket was refilled by the 2nd bucket over the 4yrs. Thus it finished the 4th year at $80,600. And that is why the 2nd bucket went from $420K to $240K. The 3rd bucket was never touched and went back to the original amount.
This bucket system is similar to a 55/45 portfolio where you always liquidate from bonds first. Returns from bonds going forward are probably not going to be good, so more like a 80/20 portfolio though.
Well... that 2% inflation rate didn't age well hahaha
Maybe consider a blend of the 4% rule and the bucket strategy, such as when your investments in bucket #3 have a surge. You can then pull some extra money beyond 4% out and put them into buckets 1 and 2 so that you are prepared for a market down turn. Love you videos.
My thoughts exactly
I see the 4% rule as a guide to how much you can spend per year. The bucket strategy is a management tool to help you protect your assets in the downturn years. However, a bucket strategy can be montecarlo-ed and a real probability of success can be assigned to a specific withdrawal rate/ bucket system strategy.
That seems reasonable Rob
Very informative. I question all three strategies: bucket, 4% rule and 60/40 stocks/bonds, in this current pandemic/economic crisis. Interest rates are the lowest they've ever been, unemployment is near depression levels and the economic recovery is a wild card. How do you pick a retirement strategy with the new normal?
How do you feel about it now--a year later?
@@wd269 the market bounced back like never before , bucket strategy seems like a good strategy, just relying on 4% might not work perfectly for cases like 2020 dip
@@robertmarlo6668 4% has been backtested against many major recessions, and survived. The main problem is that it used a classic 60/40 portfolio originally and people think that the current situation with low rates mean that the bond portion won’t act in the same manner going forward.
You have to do something...
Why wouldn't you just build an income portfolio that pays 4% in dividends and live off the 40K, then you never have to sell shares even if there is a market crash. The dividends (if chosen well with stable dividend paying companies) keep coming in regardless. You could still keep a bucket of cash in money market account as emergency fund.
@A I Wasn't the point
Stocks that pay dividends also get hit by market downturns and may substantially reduce or even eliminate their dividends. I've read that lots of banks did this during the 2008-2009 downturn.
@@tomrobinson1388 Pick dividend aristocrats and kings that have long term (multi-decade) record of increasing (and never eliminating) their dividends, that's the key. Banks were the cause of 2008 crisis, so yeah they got hit hard. Have to understand what u pick and why.
@@HansMcGruber you mean like GE??
@@pstratt1294 Have to choose well, but there is always risk with stocks
Thank you , great video
i use this rule because it makes lots more sense to me except i make the cash bucket 5 years and the rest of my money wih 40 bond 60 stock allocation. my experince told me it can take 5 to 7 years to recover from market crash
That works!
The scenario of the 4% rule isn’t realistic using 100% stocks. No retiree is going to start retirement with that allocation. The 4% rule should use around 50-50 allocation between stock and bond funds.
If you have enough in the cash bucket you can have 100% stocks in growth bucket
You've mischaracterized the 4% Rule. The whole point is that you can pull out 4% _even if_ the market crashes. 4% accounts for the natural cyclicality of the stock market, including crashes. Market goes up 20%? Withdraw 4%. Market does down 20%? Withdraw 4%.
There's only really a problem if you start withdrawing more than 4% during bull markets.
Jared Spencer that percent was based on bonds paying a good interest rate. We currently cannot count on bond interest when stocks fall like we did in past decades.
Jared doesn't understand the 4% rule described by Bengen. A constant 4% withdrawl does result in not running out of money which is a good thing.
I have a similar plan, probably more aggressive than this of maintaining three years of cash in laddered CDs or a combo with corporate bonds. The other bucket is fully invested with 70%+ in ETFs - only pulling money out to fill bucket 1 when the market is up. When the market is down - generate additional money by selling weekly covered calls and roll them when/if your ETFs recover gains.
What is never explained is when do you replenish the buckets - I mean, after 10 years you have emptied the cash bucket and bucket 2 and then what? Do you start with 3 buckets again. No-one every explains this with a multi year example.
You're comparing a portfolio of 100% stocks for the 4% rule, to something close to 50/50 stocks/bonds for the 3 buckets strategy. Apples and oranges...
4% was based on a 60/40 portfolio…
So, in a normal market, I the first bucket is refilled by the second bucket, and the second bucket is refilled by the third. But when the market drops, You stop refilling the second bucket until the market recovers (or the second bucket is depleted). While this makes a great deal of scene to me, you are increasing the portion of your portfolio invested in stocks as the marked declines. Some would call this "Market Timing" which seems to have a bad rep with many advisers...
Very good points made. Additionally, when the market crashes 50%, it will take a 100% growth to actually reach pre crash levels. If purely relying in the 4% withdrawal rule, it will take more than a 100% growth to reach pre crash levels!
Love your video :) What about just 2 buckets? Have 2 years expenses set aside as a giant emergency fund, and not draw money from investment at that one year when the market crash 20% plus? And slowly refill that bucket back up as I never spend all the withdrawal every year anyway? (And follow the regular 4% rule otherwise) How does that sound to you? I am retiring soon and that will be my plan I think :)
If you can drop your spending when the market drops that works, but it is much more risky.
If you look at for example the french stock market the CAC 40, in may 2007 it was above 6000 points to crash down to below 3000. Thanks to the Euro financial crisis the bounce back to 4000 was followed by another drop so 2011-2012 were at the 3000 mark. markets.businessinsider.com/index/historical-prices/cac_40/1.5.2007_27.5.2012
That is a good 5 years of your portfolio being slashed in half, 4%*5=20% if you can drop your cost by 50% too, old cost level would drop your assets by 40% in those 5 years. Debt levels in the US currently are higher as they were in France during that crisis, and are exploding like crazy the last years. I think it is unlikely that the US has the same kind of crisis, but it is not unthinkable.
The 10 year bucket is the buffer for such extreme cases, on average every 7 years there will be a crisis that normally takes 2-4 years to recover most of the losses. I'd advice you to at least get a 5 year bucket for the medium time, also the 1 year bucket should be placed in GIC's or some other 2 year CD's so that you still get a small return on it. That's at least my personal plan
Thats only $800 a year.
That’s exactly what I’m doing, I don’t get the purpose of the middle bucket if you have enough in the cash bucket. Then trim the 3rd bucket on the 20% years😉
I like the idea of two buckets also. The only difference is that I would put more than 2 years worth in the cash bucket since it sometimes takes more than 2 years to recover from a crash. It also minimizes having to withdraw from the stock bucket which would allow it to grow more as well as allow you to withdraw during ideal times. I haven't decided yet how much I will have in each bucket but I'm really a fan of the idea.
I’m going with a 2 bucket system, too. Currently I’m keeping 4 years’ worth of expenditures in “cash”, and the rest in stocks. If the market is up for the most recent 12 months, I will take from the stock side and leave the cash alone. If the market is down, I will take from the cash side (and gradually rebalance once the market goes back up). This was outlined in the book “Investing at Level 3” and it makes sense to me.
In your scenario I’m not sure why you stated the couple will not have a social security income stream. ??
Because that's unreliable at best
You don’t sell any of your shares. You live off of dividends and keep your consistent dividend payers and hold tight for 20 plus years unless there is intrinsic issues. You don’t sell shares or eat into capital for your funds. This vid doesn’t make much sense. I have clients who only take out what they earn in dividuends
My friend, to be able to live off dividends, you will need a much bigger portfolio. However if say a portfolio is given dividends of 4% annually, then you may be right, in that no stocks need be sold.
The 3 bucket approach always seems somewhat over simplified in every explanation I see. Add a checking account, savings account, traditional brokerage account, Roth and a 401K and it starts to look like 9 or more buckets.
His 3-bucket strategy differs somewhat from the one my advisor told me about. Bucket #1 should contain all of your non-retirement accounts. Bucket #2 should contain your pre-tax retirement accounts (traditional 401k/IRA). Bucket #3 should contain your Roth accounts (Roth 401k/IRA). The rest of it is similar to what was presented in this video.
10 years of expenses in safe investments and the balance in stocks used to replenish the first two buckets - no way can you lose and you will sleep sound knowing your immediate needs are covered. Stock market crashes rebound and that last bucket has 10 year cycles to recover. Works for me
Great video, I just cannot except that it is common practice to retire in your mid 60's who ever thought that was a good idea lol if there is a time to enjoy and be active it's early and decrease your burn rate when you're 60+? Makes more sense to me.
Medical expenses rise considerably after 60. Current estimates are that a couple retiring today will need $300,000 in assets ($150,000 for an individual) to cover medical for the rest of their lives. Decreasing your burn rate later in life might not be feasible therefore and set you up to run out of money.
@@tomrobinson1388 Thankfully here in Canada that isn't a concern. I'd hate that.
I plan to do something similar - I plan to retire early and delay my SSI until my wife is eligible. I'll have a small pension that will also cover my health insurance...so I plan to spend little for the first 5 years and then SSI will give m a substantial income increase
Hey Daniel, I have a question. At about 10:30 in the video should the 10 years bucket have been $320,000 as I thought it would be covering years 3-10? Great video, really enjoyed it. One of the best channels out there that I recommend to friends!!!
This made no sense
Good stuff. I am not a fan of the 4% design. I established my bucket plan 20 years ago. Long term growth bucket is full, mid range dividend income bucket is full, filling short term income now for FI in 2021. It’s a magnificent sanity stabilization strategy for years like 2020 and prevents me from losing sleep.
Well said!
when the market drop 50%, you should draw 20,000 instead of 40k and supplement with cash reserve.
@5:09: But the "4% rule" assumes a 50% treasury allocation, which is your second bucket, so there's no more inherent risk in what you're saying than there is in the 4% rule.
This complicates things too much most of the people who i know who are rich dont do this.
May I ask what the rich people you know do do? If not this, then what? I’m interested in what rich people are actually doing with their money and what is and isn’t working. Thanks!
Long-term also means tax advantaged accounts, correct? And the move from these tax advantaged accounts to a brokerage account to hold the income bucket. The point of this strategy, I think, is that the income bucket give you flexibility to drip into the near-term bucket, as required, and be refilled from the tax advantaged accounts when the market is rocking.