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As you near your retirement and plan to transition from your accumulation to income years, it is important to have a strategy which allows your assets to continue to grow but also covers your immediate needs. The 3 Bucket Strategy separates your income needs today while allowing your funds the opportunity to grow for the next 20 to 30 years of your retirement.
The first bucket holds your cash or cash equivalents, the second contains your bonds and the third bucket is comprised of your equities. The amounts per bucket are determined based off of your annual income needs. This amount is determined by taking your fixed income amounts (e.g. social security benefits, pension, etc.) and deducting them from your total annual amount needed to cover your expenses. For example, if your projected retirement expenses are $75,000 and your household social security benefits are $40,000, your assets needed to make up the difference is $35,000. Once this amount is determined, the rate in which you are withdrawing your retirement assets should be at or below 5%. Studies have found that if your withdrawal rate is 5%, your assets should last between 25 to 30 years. At a 6% withdrawal rate, your assets should last between 15 to 20 years and a 4% withdrawal rate should allow your assets to continue to grow for your lifetime.
Let’s assume that your annual withdrawal amount is $35,000 as we build out your 3 Bucket Strategy. In Bucket 1, I recommend one to two years of annual income needs ($35,000 to $70,000) be held in cash and/or cash equivalents. These funds are used for your immediate income needs, which allow the other portion of your retirement portfolio to recover if the stock market were to become negative.
In Bucket 2, I recommend two to three years of annual income needs ($70,000 to $105,000) to be invested into a bond portfolio. The goal of this bucket is to keep pace with inflation and be available when Bucket 1 depletes. One of the benefits of bonds is the coupon/interest being paid, which I have clients settle into cash to build up cash holdings in Bucket 1 without having to liquidate shares. Between Buckets 1 and 2, you should have two to five years of annual expenses covered.
The remainder of retirement assets belongs in Bucket 3 and invested into an equity portfolio. The importance of this bucket is long-term growth to keep pace with cost of living and medical expenses. In years the stock market is positive, I recommend rebalancing the over performance into Bucket 1 to replenish your cash for future withdrawals. Also, have any dividends and capital gains settle into cash rather than reinvest to build up the cash in Bucket 1.
It is important to develop a successful retirement income strategy in order to achieve a comfortable retirement. Being too conservative by allocating too much of your overall portfolio toward cash could erode your purchasing power over time. However, being too aggressive might put you in a position to have to liquidate shares in a declining market which might not allow your funds to fully recover.
Your retirement strategy should be developed at least three to five years prior to your anticipated date of retirement. If you are looking for a retirement income advisor, I can help develop a balanced approach based off your timeframe and goals. I would enjoy having a conversation with you to review options for your retirement income needs.
Material discussed herewith is meant for general illustration and/or informational purposes only, please note that individual situations can vary. Therefore, the information should be relied upon when coordinate with individual professional advice.
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