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Retirement Income Bucket Method
The biggest concern retirees have is maintaining a stream of income. Stock market volatility and economic crises can put a dent in a portfolio. One way to ensure sufficient income is to use the bucket method.
The bucket method involves dividing your money into separate pots or buckets. One bucket will be for cash for the current year's expenses. The second will be in ultra-conservative investments for the next two to five years. The final bucket will be invested in longer bonds or stocks to grow your money and protect against inflation.
This method provides a more secure income stream by ensuring that you are not drawing from your portfolio when a bear market is occurring. You can quickly deplete a portfolio of stocks if you are withdrawing too high a percentage when stocks are in a decline. The bucket method creates a plan that gives you both income and time for your portfolio to recover in a downturn.
You first need to determine your income needs. You will need to subtract any social security, pension, or work income from your total annual expenses. The remainder will be the income you need to create from the first two buckets.
For example, suppose your yearly expenses are $50,000. You receive $30,000 combined from social security, pension, and a part-time job. That leaves an income shortfall of $20,000 that you must cover. Your first bucket will need to contain $20,000 in cash investments for the first year of expenses. The second bucket will need $80,000 to $100,000 to cover the next four to five years of income needs.
Bucket one can be invested in a savings account, money market account, money market mutual fund, or four-week Treasury bills. You want this bucket to be very liquid so that you can get money quickly. You could keep a month or two in your checkbook and use T-bills for the remainder. Do what works for you.
Bucket two can be invested in certificates of deposit (CD) or shorter-term treasury bills and notes. A short-term bond fund can work too. Municipal bonds are a good choice if taxes are a concern. The bond fund may lose a little value in a rising interest rate environment though. You can ladder individual CDs or Treasuries to keep money available while getting higher interest rates. Spreading the money over a CD/bond ladder based on six months or a year increments is a good method.
The final bucket can be invested in long term bonds or stocks. This is where you plan to grow your money. These investments should keep ahead of inflation. Longer bonds will lose value in a rising rate environment. You may wish to use an intermediate-term bond instead. Either way, a mix of stocks and bonds is important. Dividend stocks are a good choice as well.
One last point. Every year you will plan to transfer income from each bucket to the next lower bucket. A year of income will be transferred from bucket two to bucket one. Ideally, a year of income will be transferred from bucket three to bucket two. This strategy works fine in a good stock year. In a downturn, though, you would be wise to hold off on selling investments and wait to transfer money until an up year. A mix of stocks and bonds may still allow you to transfer though. Bonds may be up when stocks are down. In that case just sell some of the bonds to make the income. Any extra can be rebalanced into the stock side of the portfolio.
Are you interested in a simple portfolio to save for retirement? Please check out my book on building a simple retirement portfolio that is available at Amazon.com:
Investing $10K in 2014 (Sandra's Investing Basics)
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