Investing in retirement….the “Bucket Strategy”

Most everyone in the FIRE (Financially independent, Retired Early) community has their own unique investment strategy/philosophy.  From what I’ve gathered from many FIRE bloggers, they are passive index-investors.  If I did a survey I’d probably find that most have a heavy allocation (some fully invested, others at least 70% in stocks) to equities in the form of stock index funds (Vanguard is by far the most popular fund provider in this community) and/or ETF’s (SPY and VTI for instance).   This information I’ve gathered is based on how FIRE bloggers invest while in preparation for early retirement.   How should one invest immediately before and during retirement?  One way is the bucket strategy.

The bucket strategy is a method for funding retirement cash-flow needs while also maintaining a diversified portfolio of stocks, bonds, and cash, using your portfolio assets to create a consistent paycheck.  It’s a very simple and risk-averse strategy.  Let’s focus on the word “risk.”  The real risk of investing in the stock market is the short-term volatility.  If a pre-retiree blogger for instance, is fully-invested in index funds and ETF’s and the market suddenly falls by 30%, will this force him/her to postpone their early retirement?  That would suck!  This happened to so many dear folks in 2008.  They’d worked so hard for so long, their eyes on retiring with fat 401-k balances.  All of a sudden the market took a crap, the S&P 500 suffered a 37% drop.  In fact from Oct 1st, 2007 thru May 6, 2009 (bottomed at exactly 666-level) the S&P 500 dropped 56.7%!   Over half, in a year-and-a-half!  How would that interrupt your plans for early retirement?  Is it any wonder I’m currently allocated at less than 20% to equity investments at present?

The bucket strategy is designed to provide cash-flow needs in retirement so that the retiree won’t have to sell equities at the worst time, to fund their daily expenses.  The name “bucket” is appropriate because the investor literally allocates their assets in three buckets; one to fund short term cash flow needs, the next bucket to be allocated to income investments, and the final bucket is invested for portfolio growth.   The first bucket’s assets are invested in short term, risk-free assets like money market funds and CD’s or treasury bills.  Two-three years living expenses should be held in this bucket.   This in the opinion of many financial professionals, is enough time to allow for a bear market to come and go.  Personally, I’d keep an additional year’s worth of expenses in an “emergency fund” outside of bucket one, in the event we experience a recession and protracted bear market.

The second bucket should be invested in intermediate-term bonds (I prefer individual bonds, not bond funds, this provides yield-thru-maturity with no worries in bond market volatility), REIT’s and dividend-paying stocks and/or ETF’s.  This bucket should throw off enough income to fund a year’s worth of bucket number one.  I believe the size of this bucket should be at least five years (or more as I’m conservative) worth of living expenses, invested for balance and providing dividend income.  This bucket should resemble a typical conservative, moderate-allocation portfolio.

Bucket three is to provide overall portfolio growth and thus, should be tilted more toward equity “heaviness.”  This is in essence, the longest-term portion of the portfolio.  Growth stocks and funds should dominate this bucket’s investments.  Have a favorite actively-managed fund? Place it in this bucket.  Have a wish list of several individual growth stocks you’re interested in purchasing?  They belong in bucket three.

On rebalancing: The bucket strategy methodology calls for adding assets back to bucket one as the bucket’s cash is spent down.  Once per year you transfer one year’s worth of dividends from bucket two to bucket one; so one more year’s of living expenses are covered.  This is a once-per-year “rebalancing”   which makes this whole “bucket thing” simple and low maintenance retirement investment plan.   It doesn’t get much simpler and risk-averse as this plan.

Illustration (This is a hypothetical portfolio, Fiction!):

Mr Fire’s Bucket One ($225k):   One year’s expenses ($75k) invested in a online high yield savings account (currently yielding 1.9%),  Two additional years ($150k) invested in a CD ladder.

Mr Fire’s Bucket Two:  ($750k):  40% invested in real estate crowdfunding deals (with maturity dates of up to five years, yielding preferred rates of 8-10%), 40% in dividend paying ETF’s (split evening along DVY, HDV, NOBL, SCHD), 20% ($100k) invested in individual dividend-paying stocks of my choosing while selling covered calls against them

Mr Fire’s Bucket Three ($1.25 million):  50% invested in a handful of actively-managed open-end mutual funds whose managers I favor ($100k each in COBYX, DODGX, HWAIX, FPACX, OAKLX & OAKWX), 30% invested in ETF’s & Funds (IVE, VDC, VTI, VO, VIAAX, VINEX),  20% invested in a hedge fund limited partnership (a long/short fund)

THIS IS NOT ADVICE!  I am not an investment advisor, nor a professional in the financial services industry.  Stock market investment do have risks.  This blog is for informational purposes only and the reader is 100% risk responsible for any and all trades and investments made.




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