The Bucket System

The Bucket System concept has been around for a while in one guise or another, but it has been popularized by a San Diego Financial Planner named Raymond Lucia in his book 'Buckets of Money - how to retire in comfort and safety'. The same basic idea in more technical papers uses the term 'bridge' instead of 'bucket'. The concept is quite different from the traditional way of thinking about investing during retirement.

Traditionally, investors in retirement are facing shorter time horizons and thus have less time to recover from a down market. This problem is handled by increasing the investments in 'safe' investments, perhaps using the rule of thumb of 'investing your age in bonds'; for example if you are 65, you would invest 65% of your assets conservatively.  With improved health and increasing lifespan, the rule has been stretched to 'investing your age less 10 in bonds', so a 65 year old would invest 55% conservatively. This is an admission of the problem with this approach. Conservative investments just don't offer enough appreciation to counter the effects of inflation. On the other hand, putting too much in stocks (equities) has its own problems, primarily that a down market can cause significant harm to a retiree's savings that are needed for income.

How does the Bucket System help in this dilemma? Well, here's how it works: fill the first bucket with cash. Because it is in cash (say CD's or very liquid and safe US government securities) it is not going to lose value (though not gain much either). This is the money you will spend over the next 2 to 5 years. Not just spend the interest, but spend the principal as well – the bucket will be empty at the end of the chosen period. You can now relax knowing you have your expenses covered for the next so many years. You have decoupled yourself from the ups and downs of the stock market.

You also prepare a second bucket and fill this with a relatively safe type of investment, say bonds, preferred stocks, or less volatile, income producing equities. This money is available to refill the first bucket once it is drained. It should contain sufficient money that buckets 1 and 2 together provide at least 10 years of income.

The rest of your money goes into a third bucket, invested in growth equities with a long time horizon. This gives the money in bucket number three a good chance to grow and be able to refill bucket number 2 when the time comes. A big advantage of the bucket system is that because the money in bucket number three is not needed for many more years, people are less likely to panic in a down market and sell everything just at the wrong time.

At the end of the first period, there will be nothing left in bucket number 1. Convert the appropriate amount of money in Bucket number 2 into cash and tip it into Bucket number 1. As the value of Bucket number 2 is reduced, look for the opportunity of an up market (not a down market) to move capital from Bucket number 3. This topic is covered in the article The Flip Side of Dollar Cost Averaging.

If equity market conditions are negative, the replenishment of Bucket number 2 is delayed until conditions improve. At some point Bucket number 2 is refilled from bucket number 3 and the money is then invested more conservatively. The remaining money in bucket number 3 keeps growing for the next round.

The system is flexible and can be adjusted according to the number of years it needs to operate. With sufficient money in Bucket number 3, it could go on forever, but in most cases the principal will be spent down over an agreed time period. The core benefit is that a sizable portion of the total amount available will have been invested to benefit from the higher return of equities, but with a reduced risk of having to liquidate equities at the wrong time.

The Bucket System is one of the options recommended by Bay Area Planners to our clients. We work with clients to identify the time periods, the amounts to put into each bucket and the type of investments that each bucket will contain to give the planned rate of return. We are available to manage the safe movement of capital out of Bucket number 3. We like to couple such a distribution plan with longevity insurance.

If you like the idea of the Bucket System and want to see if it would work for you, call (408) 725-7135 or click here.

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