When you start planning for retirement, it can become overwhelming very quickly. This is especially true at a time when markets go up and down quite often as well as when you are starting to plan for a longer than average life expectancy. One easy way to achieve your goal of both growth and security for your retirement fund is through the use of the 2-bucket strategy. The 2-bucket strategy separates your retirement savings into two separate buckets, one bucket is for your short-term needs (stability) and the other bucket is for your long-term needs (growth). This way, you are able to manage your risk while continuing to receive an income.
Here is a complete guide to understand how this strategy works, what makes it effective, and how you can get started.
What is the 2-Bucket Strategy?
The 2-bucket strategy separates your retirement assets into:
- Bucket #1: Short-Term Income & Capital Preservation
- Bucket #2: Long-Term Growth
Each bucket has its own time horizon, purpose & risk tolerance.
Instead of viewing your portfolio as one large bucket of money, the 2-bucket strategy will allow you to mentally & systematically categorize your money into each bucket based on when you will require access to that money. Once your assets are categorized, you will have less worry about the volatility of the assets in your retirement portfolio during downturns in the financial markets. You will also have developed a systematic way to withdraw money from your retirement portfolio throughout your retirement years.
Bucket #1 – Short-Term Income and Capital Preservation
Purpose: To provide you with reliable income for approximately 3 to 7 years.
The purpose of the first bucket is to cover the essential costs of living such as:
- Housing
- Utilities
- Groceries
- Health Insurance
- Healthcare expenses
- Basic lifestyle spending
- Typical Investments in Bucket #1
- High-yield savings accounts
- Money Market Funds
- Short-Term Bonds
- Certificate of Deposits (CDs)
Capital preservation is the primary function of a bucket containing short-term investments with little potential for growth. Even though returns are usually small, the main benefit of capital preservation is that you won’t be forced to sell stocks in a down market.
Why Is This Bucket Important?
Market declines will happen. If you must withdraw money from your investments while they are less than what you paid for them (i.e., on a paper loss), you have locked in a loss and decreased your ability to help with the long-term growth of your entire portfolio. If you have a few years of living expenses in safe investments, you will be able to give time for your growth investments to recover.
In particular, this is very important in the early years of retirement because it is a time frame in which you are more susceptible to “sequence of returns” risk.
Bucket 2: Long-Term Growth
Objective: To accumulate wealth over the next 7 years or longer to fund future income needs.
This bucket is invested for growth, and its goal is to outgrow inflation over a multi-decade time horizon.
Typical Investments Found in Bucket 2
- Broad stock market index funds
- Dividend paying stocks
- Exchange-traded funds (ETFs)
- Balanced mutual funds
- Real estate investment trusts (REITs)
Because the funds in this bucket aren’t needed for a long time, they can tolerate fluctuations in market price.
Why Is Growth So Important?
The average retiree will live for at least 25-35 years. Over that time, inflation will continue to rob retirees of purchasing power. Retirees cannot afford to not have growth investments.
The assets in Bucket 2 provide:
- Protection from the inflation rate
- Protection from an extended life span
- Potential for capital appreciation.
Over time, the increase in value in Bucket 2 will rebuild Bucket 1.
10 small business ideas that you can start right from your home
A versatile writer mainly works on trending news, daily updates from politics, business, crime, current affairs and entertainment.
