What’s the best way to build a robust retirement portfolio that can ride out market fluctuations and provide steady and dependable income? In the 1980s, renowned U.S. financial strategist Harold Evensky devised what we believe is a smart approach. He called it the ‘Bucket strategy’.

I grew up in the 1970s and 80s, and the one thing I remember – apart from the flared brown corduroy jeans – was the measurably higher interest rates available to those living on their retirement savings. In 1981, for example, the average interest rate for 12-month term deposits was 13% per annum. The rate was high enough (and prices for everything significantly cheaper than today) for many retirees to experience a reasonable, if not enjoyable, lifestyle without needing to ‘risk’ their capital or dip into their retirement savings. Even when I entered the Financial Services industry in 1989, Superannuation Funds were offering ‘Capital Guaranteed Funds’ that paid some 17%.

Today, investors approaching retirement must be understandably nervous about how much they need to have accumulated to meet their lifestyle objectives, acknowledging that some of the saved capital may need to be drawn down in addition to the income earned. For those without substantial super funds, and even for those with substantial funds, this blog will provide insight into a framework for building a retirement portfolio.

Enter the ‘Bucket Methodology’ in retirement asset management, a brainchild of the renowned U.S. financial strategist Harold Evensky. I had the pleasure of meeting Harold at the USA Financial Planning Association Conference in Orlando in 2004, where he offered a blueprint for retirees to maximise their financial assets and the chances for a stable retirement income long after retirement. Some retirees are fixated on income-centric models. This may inadvertently encourage them to invest in riskier securities, such as CBA. The Bucket Methodology represents an alternative to this, and is grounded in a simple yet potent principle: funds allocated for imminent expenses should remain in cash, regardless of the yields.

Conversely, assets which are set aside for the more distant future can be diversified across a broad spectrum of longer-term investments. The immediate cash reservoir in Bucket One ensures retirees have a sufficient financial cushion to withstand and ride out the inevitable volatility in their long-term portfolio.

Time period     Investment type
1. Short            Bucket One:
A cash bucket. This bucket is designed to meet immediate income needs for a minimum of two years. The capital in this bucket is for spending on those needs.

2. Medium        Bucket Two:
Less conservative than Bucket One but more conservative than Bucket Three, and offering medium-term stability to fund Bucket One’s future years.

3. Long             Bucket Three:
The growth bucket invested more aggressively to provide the opportunity to grow savings and ensure longevity. Returns in this bucket will vary more than the other two buckets.

The Bucket strategy helps individuals endure, survive, and thrive amid a risk referred to as sequencing risk, which is the risk of a significant decline in asset values early in the investment journey. Understandably, and without gainful employment, many retirees are required to make regular fixed-dollar withdrawals (pension drawdowns) from their retirement portfolio. If the retirement portfolio is entirely invested in volatile securities, retirees may experience the opposite of the ‘dollar-cost averaging’ effect when prices fall.

At lower prices, a retiree would be forced to sell more units simply because more units are required to meet their minimum pension payment obligation. And then after those units are sold, the remaining portfolio is smaller. With fewer units, a greater burden is now placed on the remaining units to recover the losses. This is the situation faced by many Industry Funds which provide unitised solutions via managed funds. The key to the bucketing strategy is being able to ‘target income’ from the short-term bucket while leaving the medium and longer-term buckets alone in times of market stress. This isn’t easy to do in a unitised environment, ie XYZ Balanced Fund. It is essential that large losses early in the investment journey are avoided or at least mitigated. A major loss early in your retirement years can be irrecoverable.

Bucket One: The immediate financial buffer
Central to the Bucket strategy is the need to quarantine cash from volatile assets that is needed to cover short-term living expenses for a period of two to five years – the estimated time required for markets to recover. Its primary purpose is to offer a solid foundation for covering immediate expenses not met by other income channels. To determine the amount for Bucket One, start by outlining the projected annual fixed expenditures required for maintaining the lifestyle. Discretionary expenses, such as an overseas holiday or car replacement, should not be factored in. The residual figure provides a clear indication of the funds required to be sourced from Bucket One. A prudent investor may double this number. But this depends on your overall capital position. Cash and Term deposits are useful tools.

Subsequent buckets: expanding the strategy

Bucket Two:
This Bucket embodies five or more years of anticipated expenses, emphasising income generation and stability. It is predominantly comprised of robust income-producing assets, including a selection of high-yielding investments such as infrastructure funds, equities, Real Estate Investment Trusts (REITs), hybrid securities, and fixed interest and credit investments. The returns from this segment can be utilised to replenish Bucket One when necessary (and sometimes Bucket Three if the opportunity presents itself).

Bucket Three:
This bucket is primarily composed of large and small capitalisation equity funds, both domestic and global, and alternative investments. While promising the most substantial long-term gains, this bucket also bears the potential for considerable losses due to its higher volatility. Buckets One and Two are crucial to deter premature withdrawal from Bucket Three during market downturns. During downturns, if returns from Bucket Two permit it, and if spending from Bucket One allows it, investments in Bucket Three may be subsidised from Bucket Two.

Re-Balancing the buckets
At some point each year, the buckets are rebalanced with the objective of starting a new year with two years’ worth of lifestyle income needs in Bucket One.
In this instance, the first step is to examine the investment returns in Buckets Two and Three. Depending on performance, there are three possible results. The first scenario is that both buckets produced a positive result. The second is that both produced a negative result, and the third is that one bucket yielded a positive return, while the other yielded a negative one.

The second step is to withdraw from the Bucket(s) that have generated a positive return, ensuring sufficient funds to meet the objective set for Bucket One – two years’ worth of income needs at the start of each year.

The Bucket with a negative year remains untouched. If both buckets are negative, they both remain untouched. This is the reason Bucket One has two years’ worth of income needs at the commencement of the strategy, so that the retiree can ride out the dips.

Suppose the cash balance in Bucket One at the end of any year is less than two years’ worth of income requirements. In that case, equal amounts are drawn from Buckets Two and Three, irrespective of their earning, to replenish the Cash Bucket so that it begins the following year with the two years’ income requirement.

Setting up and maintaining the strategy demands attention and discipline. Deciding how much to invest in each bucket and the asset mix within each requires careful consideration. One must also determine the rules for re-balancing the buckets, and discipline must be applied to following those rules.

Further, if the retiree holds too much in Buckets One and Two, relative to Bucket Three, the long-term growth bucket won’t out-earn the withdrawals in Bucket One due to inflation. This would result in a decline in income as the retiree ages.

Your financial journey is unique. At Future Gen Solutions, our experienced financial advisers create a dynamic strategy tailored to your specific goals, whether it’s wealth accumulation, tax efficiency, or investment growth.

With expert guidance at every life stage, we help you confidently navigate financial decisions, from building wealth and securing your financial future to succession planning and legacy protection.