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unbiased2020

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08-04-2020
12:03 AM

For those using "buckets" for retirement...

I'm modeling some numbers for *possibly* using the bucket approach for retirement, but I can't find a formula to calculate how much should be in Bucket 3 on the day I retire. So instead, I made one up--which could be a great way to end up poor.

Buckets 1 & 2 are straightforward: Low bond/cash returns = "pre-fund" with 10 years' of yearly spending + inflation, minus a smidge for some compound interest growth. Ok, easy enough.

But Bucket 3? My non-financial planner head says put in enough to grow, in 10 years, to fill Buckets 1 & 2 + enough leftover to grow and do it all again over rolling 10 year periods. Rinse, repeat. Sure, I know I'm not ignoring Bucket 3 for years and then just praying it's enough when I open my statement. There will be rebalancing, dividends, etc. "along the way"--but there's gotta be some yardstick for the starting size of Bucket 3--and that's all I got.

But I didn't read that anywhere, I just made it up. So that's why I'm on this forum to talk to smart people who aren't destitute. Is that how you figured out the # to put into Bucket 3? Heck, I need a fighting chance to avoid eating dogfood in the barn when I'm 70.

So -- if you're using this approach, how'd you come up with your magic number to put into Bucket 3?

17 Replies

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SJ60

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08-04-2020
04:22 AM

Re: For those using "buckets" for retirement...

I am near retired and I do not use the bucket system, but here is my take for what it is worth.

You'd want at least 25 years worth of portfolio withdrawals without any growth or inflation adjustments, just to keep it simple. In other words for a million dollar portfolio, you expect to take out 40K per year for 25 years. Since your investments should grow faster than the inflation rate, you should be able to get 40K inflation adjusted, and hopefully for more than 25 years, depending on how much better than inflation you do. After you fill up buckets 1 and 2 with 10 years worth of safe investments, the remaining 15 years worth go to equities. Not coincidentally, this works out to a 60:40 mix, beloved of many, and well proven for decades. Consider - fill buckets 1 and 2, and shove everything else into bucket 3. Starting out, if bucket 3 does not equal 60% of the total value, you may have a problem. If more than 60%, your safety margin is larger.

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VA-Tech

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08-04-2020
06:17 AM

Re: For those using "buckets" for retirement...

Perhaps I misunderstand your question. But according to classical "bucket" theory, whether you have 2 buckets, 3 buckets, or 4 buckets, **the total of all buckets should equal all your total intangible financial assets** (taxable, tax-deferred, and tax-exempt accounts). In summary, for a 3 Bucket model, Bucket 3 is whatever is not in 1 or 2.

I have a client who uses a 4-bucket system. Here is his bucket management philosophy:

• Bucket 1 is the client's Short-Term Bucket. These are the most conservative of all buckets and should provide the immediate income (both essential expenses and desired discretionary expenses) needed for the next 2-3 years. Bucket 1 obviously includes bank accounts (cash). It also includes cash-equivalent investments (e.g. short-term bonds). Collectively, this Short-Term Bucket is the one that should provide comfort when the market is at its most volatile, because regardless of what happens in the market, you have 2-3 years of income in Bucket 1. This also gives the other buckets more time to weather market fluctuations, before you will need to access that money. But if the conservative component of the portfolio is too large, it can create significant drag on the portfolio's overall returns.

• Bucket 2 is the client's Medium-Term Bucket. The investments in this bucket are more aggressive than Buckets 1, since you are looking for more return and yield from these investments. This bucket is designed to be conservative and produce income with moderate risk. It should primarily feature large-cap stocks often paying decent dividends and short/intermediate grade bonds. Ideally Bucket 2 should have a valuation of 4-6 years of living expenses, roughly twice the size of Bucket 1.

• Buckets 3 and 4 are the client's Long-Term Buckets. By convention, this particular client's Bucket 3 is for tax-deferred accounts (401Ks and traditional/rollover IRAs); Bucket 4 is for the clients tax-exempt accounts (Roth 401Ks/IRAs). This is the place for growth-oriented equities that will generally have the biggest risk/reward ratio, as well as higher-yield bonds.

There is no reason that the monies of a particular bucket need be physically in the same account. In a sense, the buckets are "virtual". Breaking the assets down into "buckets" is the easy and mechanistic part. The management of those buckets throughout the retirement period is where the real "art" is ESPECIALLY when you lay a tax-minimization plan on top of the Bucket system.

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galeno

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08-04-2020
06:25 AM

Re: For those using "buckets" for retirement...

Our moto is KISS & STC.

By mid Aug we will hold a 2 ETF port. Our 3 buckets:

50% TWSM (VT) + 45% TWBM (BNDW) + 5% CASH.

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bilperk

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08-04-2020
06:50 AM

Re: For those using "buckets" for retirement...

@unbiased2020 wrote:I'm modeling some numbers for

possiblyusing the bucket approach for retirement, but I can't find a formula to calculate how much should be in Bucket 3 on the day I retire. So instead, I made one up--which could be a great way to end up poor.Buckets 1 & 2 are straightforward: Low bond/cash returns = "pre-fund" with 10 years' of yearly spending + inflation, minus a smidge for some compound interest growth. Ok, easy enough.

But Bucket 3? My non-financial planner head says put in enough to grow, in 10 years, to fill Buckets 1 & 2 + enough leftover to grow and do it all again over rolling 10 year periods. Rinse, repeat. Sure, I know I'm not ignoring Bucket 3 for years and then just praying it's enough when I open my statement. There will be rebalancing, dividends, etc. "along the way"--but there's gotta be some yardstick for the starting size of Bucket 3--and that's all I got.

But I didn't read that anywhere, I just made it up. So that's why I'm on this forum to talk to smart people who aren't destitute. Is that how you figured out the # to put into Bucket 3? Heck, I need a fighting chance to avoid eating dogfood in the barn when I'm 70.

So -- if you're using this approach, how'd you come up with your magic number to put into Bucket 3?

Maybe I misunderstood what you are looking for also. It seems very simple. You have decided that bucket 1&2 must last 10 years. Frankly, You only need 1 bucket for cash and st term bonds + inflation. But whatever that number is, I assume it is based on an estimate of your annual expenses X 10 + inflation. That should give you an amount for bucket #1(#2). Divide that into your total portfolio amount and you will get a percentage of your portfolio going into 1 & 2. Whatever % is left becomes bucket 3 by default. Depending on how high that % is compared to your risk tolerance, you may need to put less than all of that in equities. For example, if you have 70% left, you may not want 70% in equities. If that is the case, I would merge 1 %2 and add a bucket in between with intermediate bonds, or balanced funds that seek dividends. These distributions can then be sent over to bucket 1 before it is empty.

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Gary1952

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08-04-2020
07:35 AM

Re: For those using "buckets" for retirement...

The bucket system is just a way for a person to think about and to manage their portfolio. Go to the M* homepage and click on Christine Benz's model portfolios button. She is the queen of the bucket system. It is pretty straight forward with her. The bucket sizes are determined by the number of years each bucket holds in cash needs. Any more than 3 buckets is over thinking. Good luck.

@unbiased2020 wrote:I'm modeling some numbers for

possiblyusing the bucket approach for retirement, but I can't find a formula to calculate how much should be in Bucket 3 on the day I retire. So instead, I made one up--which could be a great way to end up poor.Buckets 1 & 2 are straightforward: Low bond/cash returns = "pre-fund" with 10 years' of yearly spending + inflation, minus a smidge for some compound interest growth. Ok, easy enough.

But Bucket 3? My non-financial planner head says put in enough to grow, in 10 years, to fill Buckets 1 & 2 + enough leftover to grow and do it all again over rolling 10 year periods. Rinse, repeat. Sure, I know I'm not ignoring Bucket 3 for years and then just praying it's enough when I open my statement. There will be rebalancing, dividends, etc. "along the way"--but there's gotta be some yardstick for the starting size of Bucket 3--and that's all I got.

But I didn't read that anywhere, I just made it up. So that's why I'm on this forum to talk to smart people who aren't destitute. Is that how you figured out the # to put into Bucket 3? Heck, I need a fighting chance to avoid eating dogfood in the barn when I'm 70.

So -- if you're using this approach, how'd you come up with your magic number to put into Bucket 3?

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unbiased2020

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08-04-2020
10:09 PM

Re: For those using "buckets" for retirement...

Thanks for all the replies. My explanation of my question may be a little off so I'll try to clarify. I'm just trying to make sure I have "enough" money in each bucket so, when I turn in my keycard, I'll be able to spend from Buckets 1 & 2 comfortable that Bucket 3 will grow enough to fund the other Buckets. I can't find from Benz (who's writings are otherwise helpful) a formula to come up with this "initial deposit" for Bucket 3.

So, without guidance, I just modeled a 6% return in Bucket 3 and will aim that the initial deposit in 10 years will grow to be more than 1&2 combined. Surprisingly, the result is close to a 50/50 allocation.

I also lean on using SJ60's yardstick as using a typical 4% withdrawal over X years -- but I'm just surprised that there's not a clearer formula for calculating the amount for Bucket 3 if you already know the amounts you need for Buckets 1 & 2 for retirement.

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Mustang

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08-05-2020
05:21 AM

Re: For those using "buckets" for retirement...

Sorry if I'm out of line. I don't use the bucket approach, but I'm interested in looking at it. I'm not opposed to it. I just think its overly complicated. I read an article a long time ago that said when the bucket system was created there were only two buckets: cash and investments. Now there are three and four.

Christine Benz talks about pruning investments back to replenish the cash bucket. I always thought that meant that if stocks were up the investor sold from bucket 3 replenishing buckets 2 and 1. If not they sold from bucket 2. But I could be totally wrong. How does replenishing the buckets work?

P.S. I thought SJ60's explanation made a lot of sense.

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VA-Tech

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08-05-2020
05:37 AM

Re: For those using "buckets" for retirement...

You seem to be conflating a bunch of topics: 1) Bucket Strategy management of retirement assets, 2) Asset Allocation, and, of course, 3) Do I have enough retirement assets to retire (which opens up peripheral discussions towards spending rules, etc.)?

It isn't uncommon to meld a bunch of topics but just pointing out that your Asset Allocation __isn't__ tied explicitly to your Bucket valuations since there is no hard "rule" that says Bucket 3 need be comprised of just growth equities; it's also a good spot for higher yield (more volatile/risky) bonds.

Note, often in retirement you are spending down the retirement portfolio over a 25-30 year period. That is, your inflation-adjusted portfolio valuation may well decline over time, especially if you are maximizing your spending potential. If your Bucket 1 and Bucket 2 "valuations" are fixed (let's say 2-3 years and 4-6 years of expenses), then as a percentage of overall portfolio valuation, Bucket 3 will decline from a percentage perspective. Moreover, to the degree Bucket 3 is tilted towards equities, this results in a declining equity glide path as you get older which tends to fit well with the average retiree's psychology, i.e., get a little more conservative later in life.

And I deliberately avoided talking about "Replenishment Rules" which is another ancillary Bucket Strategy discussion and is somewhat a personal thing. It can be made mechanistic or it can be somewhat flexible. I might also point out that the absence of a hard and fast rules-based set of Bucket Strategy Replenishment Rules is a reason why some people get frustrated with the entire Bucket Strategy and do something else. If we are being honest with ourselves, to some degree almost all retirees do some form of Bucket Strategy since they usually have a cash-reserve of some sort to help mitigate short-term market volatility, i.e., nobody likes to sell depreciating assets to raise money for expense needs.

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Win1177

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08-05-2020
06:31 AM

Re: For those using "buckets" for retirement...

I think you’re making it a little too complicated. I’m heading for retirement in about one and a half years (end of 2021), and will use a 10 year “sum” of our estimated annual living expenses for the amount to hold in “buckets one and two”. Bucket #1 will be true cash, so about 6-12 months of expenses. Bucket #2 will be mainly bonds, generally medium to higher quality bonds that will be “stable” and can be sold for living expenses. Bucket #3 will throw off cash to refill Bucket #1, and if we have a great equity market, will periodically refill #2 with sales of equity.

EVERYTHING else will be in bucket #3. It will be more growth oriented, mainly equities, some high yield bonds, EM bonds, maybe a small chunk of gold, etc. In our case, bucket #3 will be large, as we have a big portfolio. So that will leave us about 80% equity. If you’re in that position, and that makes you nervous, maybe you will need to make bucket #3 less aggressive, more bonds, etc.

Buckets one and two are to provide a SAFE place to draw living expenses from in the event we have a major sell off.

Win

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In a bucket stress test described in the Morningstar article How Does the Bucket Strategy Work in Practice?, Christine Benz used initial allocations of 8% for Bucket 1, 32% for Bucket 2, and 60% for Bucket 3.

PatMorgan

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08-06-2020
06:40 PM

Re: For those using "buckets" for retirement...

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unbiased2020

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08-06-2020
09:26 PM

Re: For those using "buckets" for retirement...

@PatMorgan wrote:

THANK YOU! I missed that. She has written a lot of articles on the subject and for whatever reason I didn't her allocations in that one.

If Benz presumes that Bucket 3 should be about 10% larger in the total AA than Buckets 1 & 2, then that's a helpful start. I don't know what assumptions she used to arrive at that % allocation, but I'll dig into it.

I think SJ's suggestions are also good to make sure the entire portfolio value is "sufficient" for the long haul. I've been using benchmarks now in my accumulation phase, mostly through value averaging, and coming up with similar benchmarks for decumulation will put me more at ease to pull the trigger.

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I can't say for sure, but I suspect Christine was also using the same simple reasoning I did - 25 years, 4%/year, 2 years for bucket 1, 8 years bucket 2, 15 years bucket 3. Given the uncertainties involved that might be just as good as the most complex model one can build.

SJ60

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08-07-2020
05:28 AM

Re: For those using "buckets" for retirement...

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VA-Tech

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08-07-2020
05:45 AM

Re: For those using "buckets" for retirement...

__ highly__ dependent on the overall portfolio value. If you double the portfolio value (3M instead of 1.5M), the percentage of Bucket 1 and Bucket 2 relative to overall portfolio value would be cut in half (assuming the "target" yearly expenses of $60K isn't changed), whereas the percentage of Bucket 3 would increase from 60% to 80%. In other words, you should not just apply her initial Bucket %s of 8%, 32%, and 60% to your particular situation unless the boundary conditions of $60K yearly expenses and $1.5M total portfolio value are also applicable. Hopefully, that was obvious without me even writing it, but perhaps it's not obvious to all.

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@VA-Tech Absolutely correct. As I said in my first post, after covering 10 years in buckets 1 and 2, shovel the rest into bucket 3.

SJ60

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08-07-2020
05:55 AM

Re: For those using "buckets" for retirement...

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VA-Tech

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08-07-2020
05:59 AM

Re: For those using "buckets" for retirement...

Yeah ... it's clear you understand the entire methodology, but when the OP wrote "If Benz presumes that Bucket 3 should be about 10% larger in the total AA than Buckets 1 & 2, then that's a helpful start", I get nervous something is being missed or misunderstood!

Clearly the Asset Allocation (AA), i.e., Equity% to Fixed-Income% of Bucket 3 is very much a function of the innards (math-wise). Doubling the overall portfolio value (using my previous example) could require tuning the AA of Bucket 3 else the overall equity % of the entire portfolio in aggregate may exceed the retiree's risk tolerance!

Again, I apologize if this is blatantly obvious to all but writing it out might help someone.

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unbiased2020

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08-07-2020
09:23 PM

Re: For those using "buckets" for retirement...

I appreciate your comments, and precision. I misspoke by saying "AA" and threw you off--I should have said total PORTFOLIO. Benz in her article set the AA as a 50/50 stock/bond portfolio -- although she counted LSBRX as part of the "bond" portion which carries high equity-like risk. Her model portfolio is riskier than I would prefer.

While she doesn't expressly say how she comes up with the "Bucket 3" size, she uses the total portfolio value and determines the AA based on a 4% withdrawal rate.

For now, I'll keep running some numbers on Bucket 3 to ensure it can "last" (assuming 6% growth) to replenish Buckets 1 & 2 over time. My portfolio plan now is approximately 50/50 on AA, so it seems to mirroring hers so far. I'll share what I did and the numbers.

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VA-Tech

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08-08-2020
05:19 AM

Re: For those using "buckets" for retirement...

Sounds like we are all on the same page .... a rarity for the M* forums, lol

Good luck!