MyWealthCheckA bucket strategy splits your retirement money by when you’ll spend it: the next few years in cash and bonds, later years in shares. When shares fall, you live on the safe buckets and leave your shares alone until they recover. It’s a simple way to deal with the biggest risk of the first years of retirement: having to sell investments while they’re down.
Why does a crash early in retirement hurt so much?
While you’re working, a market fall is a chance to buy cheaply. Once you’re withdrawing, it works the other way: every sale after a fall locks in the loss, and there’s less money left to benefit from the recovery.
This is called sequence-of-returns risk. Two retirees can get exactly the same average return over 30 years, but the one whose bad years come first can run out of money while the other ends up with more than they started with. The first five to ten years matter most.
A bucket strategy doesn’t change your returns. It changes when you’re forced to sell, which is often what decides whether a plan survives.
How does a bucket strategy work?
A typical setup has three to five buckets, each invested for when its money will be spent:
| Bucket | Pays for | Invested in |
|---|---|---|
| Cash | The next 1 to 2 years | Bank savings, money market funds |
| Income | Years 2 to 10 or so | Bonds, term deposits, GICs, fixed deposits |
| Growth | Year 10 onwards | Mostly shares, with the share of stocks rising for money needed later |
Each year you spend from the cash bucket, then top it up:
- After a good year for shares, sell some shares from the growth bucket to refill the income and cash buckets.
- After a bad year, don’t sell shares. Let the income bucket run down and wait for markets to recover.
Ten years of spending in safer assets is enough to sit out all but the longest market slumps in history without selling shares at a low.
How we model it in our calculators
Our FIRE and retirement calculators and the financial planner all use a bucket strategy:
- An emergency fund of one year of spending in cash.
- An income bucket holding the next 10 years of spending in bonds and cash.
- Three growth buckets for the remaining years, with 50%, 70% and 90% in shares. The later the money is needed, the more of it is in shares.
Every result then shows a first-year crash test: what happens to your plan if shares fall 35% right after you stop working. The full method is on our methodology page.
How big should each bucket be?
There is no single right answer, but a few rules of thumb help:
- Cash: 1 to 2 years of spending. More than that and inflation eats into it.
- Cash plus income bucket: 5 to 10 years. Five years covers most market falls; ten covers nearly all of them. The longer your retirement, the more the extra safety is worth.
- Count your other income first. A pension, Social Security, the State Pension, CPP and OAS, the Age Pension or NZ Super all reduce what each year’s bucket has to pay. Only the gap needs to come from your investments.
- Keep the rest in growth. A retirement that starts at 45 can last 45 years or more, so most of the money still needs to beat inflation.
What are the downsides?
- Lower long-run returns. Money in cash and bonds usually grows more slowly than shares. A large safe bucket costs some growth in good years; that’s the price of the protection.
- It needs discipline. The strategy only works if you really don’t sell shares after a fall, and really do refill the buckets after good years.
- It’s mental accounting. In the end it’s one portfolio with a certain mix of shares and bonds. The buckets just make the rules easy to follow when markets are frightening, which is when most people make their worst decisions.
- Long slumps still hurt. A decade of poor share returns would drain even a 10-year income bucket. Being willing to cut spending a little in bad years is still the strongest protection.
Frequently asked questions
Is a bucket strategy better than the 4% rule?
They answer different questions. The 4% rule tells you how much you can withdraw; a bucket strategy tells you which investments to sell each year. You can use both.
When should I set up the buckets?
Start moving towards them about five to ten years before you stop working, so you aren’t forced to sell shares at a bad time to fill the safe buckets. Our calculators reduce the share of stocks in new investments gradually over the last 10 years before your FI date.
Do I need a bucket strategy if I have a guaranteed pension?
You need less. If a pension or annuity covers your essential spending, your investments only fund the extras, so a crash affects your lifestyle rather than your ability to pay the bills.
For education only, not financial advice. Read the disclaimer.