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Need Help With Your Asset Allocation in Retirement? Use This Bucket Approach From Morningstar


Thanks to target date funds and some simple rules of thumb, picking a mix of stocks, bonds and cash is pretty straightforward while you’re still saving for retirement. According to conventional wisdom, the further out from retirement you are, the more heavily your portfolio should be weighted in stocks. As you get closer to retirement, bonds and cash will gradually comprise a larger percentage of your portfolio.

But what if you’ve already retired or your golden years are just around the corner?

Planning for retirement or managing your portfolio while in retirement can be complicated, but a financial advisor can help simplify the process. Find an advisor today.

Morningstar’s retirement guru Christine Benz says figuring out your asset allocation in retirement requires more than a one-size-fits-all approach. That’s because your asset allocation in retirement will largely depend on your spending needs. Benz argues the bucket strategy is a great way for a retiree to tailor his asset allocation to his specific needs.

What Is the Bucket Strategy?

Need Help With Your Asset Allocation in Retirement? Use This Bucket Approach from Morningstar

The bucket strategy is a system for spreading your money across three different asset classes, which you’ll rely on at different points of retirement. Here’s how it works:

  • Bucket 1: Your first bucket is for short-term spending needs. You’ll “fill” it with cash or cash equivalents – enough to cover your living expenses in the first two years of retirement.
  • Bucket 2: Your second bucket will hold investments that you plan to convert into cash during years three through 10 of retirement. This bucket will feature bonds, but may also include income stock funds and other fixed-income assets.
  • Bucket 3: Your third bucket will be devoted to stocks and other risky assets. This will hold money that you don’t plan on needing until you’re at least a decade into retirement.

In theory, the bucket strategy allows retirees to use their cash cushion to meet short-term spending needs, all while riding out market volatility and avoiding withdrawals during a downturn.

Using the Bucket Strategy for Asset Allocation

So how much should you put in each bucket? That all depends on your income needs.

Benz offers a step-by-step guide to using the bucket strategy to figure out how much you should hold in stocks, bonds and cash in retirement. Here’s a look at her order of operations:

Calculate portfolio withdrawal amount. The first step in the process is determining how much money you’ll need to regularly withdraw from your portfolio to meet your spending needs. You can likely anticipate spending between 70% and 80% of your pre-retirement income each year once you stop working. From there, account for Social Security benefits and any other sources of income that you’ll rely on, like a pension or an annuity. Subtract this total from your annual spending needs and the result will be how much you’ll need to withdraw from your portfolio each year.

Evaluate the sustainability of your spending. Benz says the next step is testing the sustainability of your spending. In other words, figure out what percentage of your portfolio you’ll be withdrawing in your first year of retirement. Benz says a withdrawal rate of under 4% is responsible and likely sustainable. Keep in mind that your withdrawal rate may need to be adjusted based on whether you’re in a bull or bear market.

Calculate how much you need in cash. Now it’s time to “fill up” your buckets, starting with your short-term cash bucket. Benz advises parking between six months and two years’ worth of portfolio withdrawals in cash, which will allow you to distribute the rest of your assets to bonds and stocks. If you’re planning to take out $25,000 per year from your portfolio, you’ll want $50,000 in cash for the first two years of retirement.

Settle on an emergency fund size. While the cash bucket will cover your living expenses in the short term, you’ll also need an emergency fund to ensure that you can pay for a sudden car repair or a new roof on your house. Benz says you can either build this emergency fund into your cash bucket or have a separate fund strictly devoted to unplanned expenses. An emergency fund will help you avoid tapping into your long-term assets to cover an unforeseen expense.

Decide how much to invest in high-quality bonds. Following the bucket strategy, money that you’ll need in three to 10 years should be allocated to high-quality bonds, Benz says. Within this bucket, she recommends allocating your money across different types of bonds. For example, if you need $25,000 from their portfolio each year, Benz recommends putting $50,000 (two years’ worth of withdrawals) in short-term bonds, another $50,000 in Treasury Inflation-Protected Securities, three years’ worth of withdrawals in intermediate-term bonds and another $25,000 in a conservative income stock fund.

Put your remaining assets in the third bucket. The third and final bucket – your higher risk allocation – will hold the remainder of your assets. Benz says this bucket will primarily comprise stocks, but it can also feature junk bonds, real estate securities, emerging market bonds and precious metals.

Bottom Line

Determining an appropriate asset allocation in retirement requires a nuanced approach customized to your specific spending needs, Morningstar’s retirement expert Christine Benz recently wrote. Using the bucket strategy, a retiree can figure out how much he should keep in stocks, bonds and cash – and perhaps more importantly – when in retirement, he should tap those buckets.

Retirement Planning Tips

  • From asset allocation to withdrawal rates, there’s a lot that goes into retirement planning. Having an expert in your corner can really pay off. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • Some major changes are coming to retirement planning, thanks to the SECURE 2.0 Act. The sweeping legislation that was signed into law by President Biden will delay required minimum distributions (RMDs), boost catch-up contributions for people ages 60 to 63 and more. Be sure to brush up on the law and see how the changes may impact your retirement plan.

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