Planning for retirement is essential but can be complicated. The key is finding the right strategy to ensure a comfortable retirement.
In this post, I will look at two popular strategies for retirement planning: retirement bucketing and the standard portfolio approach. We’ll explore the pros and cons of each approach and see which might be better for you.
What is a Bucketing Strategy:
Dividing your retirement savings into different “buckets” based on their purpose and risk level is known as bucketing strategy. This strategy helps you compartmentalise your money for different needs. For example, one bucket might hold safer, liquid assets for short-term expenses, while another might contain riskier investments for long-term growth. Simply put, bucketing strategy allows you to categorise your savings according to their purpose and risk level.
Pros of Bucketing:
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Risk Management: This strategy aims to soften the impact of market fluctuations on immediate expenses by dividing assets into different time frames.[1][2][3][4][5]
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Behavioural Benefits: It can offer peace of mind, helping retirees stay calm during market turbulence, knowing they have a dedicated fund for short-term needs.[6] [7]
Cons of Bucketing:
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Complexity: Juggling multiple buckets can be a headache.[8]
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Asset Allocation Woes: Bucketing might lead to a less-than-ideal mix of assets across the entire portfolio.[9][10][11]
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Flexibility Crunch: It might limit your ability to adapt to changing circumstances.[12][13]
So, What is the Standard strategy?
The standard strategy for retirement savings is a simpler approach: You invest your money in a diversified portfolio based on your risk tolerance and time horizon. You won’t have to worry about dividing your money into separate accounts.
Pros of the Standard Approach:
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Simplicity: A single portfolio that covers everything! It’s straightforward.
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Potential for Higher Overall Returns: You can optimise for the long haul without the constraints of bucketing.[14][15][16][17][18] [19]
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Flexibility: Adjusting your portfolio is simple.
Cons of the Standard Approach:
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Volatility: Your portfolio rides the rollercoaster of market ups and downs without separate buckets.
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Behavioural Drawbacks: Market dips might cause more stress since everything’s tied together.
While it is not a clear-cut win for either side, we prefer simpler solutions tied in with expert advice. Our focus is much more on getting our clients to hold as much money in global equities as possible for the long term. A bucketing strategy might make sense for someone who does not have a financial planner alongside them to guide them through stormy markets. For those benefiting from expert advice, complicating their retirement portfolio could be unnecessary.
To see how we could help, you can book a free, no-obligation chat here.
[1] Evensky, H., Zinnerman, V., & Harris, S. (2019). The Bucket Approach for Retirement: A Suboptimal Adjustment to Sequence Risk. Journal of Retirement, 6(4), 87-103.
[2] Blanchett, D., & Straehl, P. U. (2015). No Portfolio is an Island. Morningstar Investment Management Research Paper.
[3] Pfau, W. D. (2017). Lifecycle Investment Strategies: An Analysis of Their Potential Benefits and Risks. Journal of Financial Planning, 30(9), 44-54.
[4] Huang, Y. C., Milevsky, M. A., & Salisbury, T. S. (2019). Longevity Risk and Retirement Income Bucketing Strategies: A Framework for Evaluating Retirement Income Sustainability. Journal of Retirement, 6(4), 104-118.
[5] Blay, D., Kritzman, M., & Turkington, D. (2018). Life-Cycle Investing: A New Paradigm. Journal of Portfolio Management, 44(4), 11-25
[6] Pfau, W. D. (2016). Behavioural Biases, Investor Behavior and Bucketing. Journal of Financial Planning, 29(3), 42-51
[7] Blanchett, D., Finke, M., & Pfau, W. D. (2018). Accounting for behavioural biases in retirement portfolios. Journal of Retirement, 5(4), 37-52
[8] Pfau, W. D. (2019). Choosing a Sustainable Retirement Strategy: A Review of Some Possibilities. Journal of Financial Planning, 32(5), 42-51
[9] Blanchett, D. M. (2015). Exploring the Risk/Return Characteristics of Bucketing Strategies. Journal of Financial Planning, 28(2), 64-73
[10] Pfau, W. D. (2015). Withdrawal Strategies for Retirement Portfolios: Theory and Practice. Journal of Financial Planning, 28(9), 58-69
[11] Blanchett, D., & Straehl, P. U. (2015). No Portfolio is an Island. Morningstar Investment Management Research Paper
[12] Pfau, W. D. (2017). Lifecycle Investment Strategies: An Analysis of Their Potential Benefits and Risks. Journal of Financial Planning, 30(9), 44-54
[13] Blanchett, D. (2014). Exploring the Risk of Ruin: A Simulation-Based Analysis of Retirement Strategies. Journal of Financial Planning, 27(7), 48-59
[14] Cooley, P. L., Hubbard, C. M., & Walz, D. T. (2003). A Comparative Analysis of Retirement Portfolio Strategies. Financial Services Review, 12(4), 327-341.
[15]Spitzer, J. J., Strieter, J. C., & Singh, S. (2007). Simple Heuristics for Retirement Portfolio Strategies. Financial Services Review, 16(1), 23-39
[16]Pfau, W. D. (2015). Withdrawal Strategies for Retirement Portfolios: Theory and Practice. Journal of Financial Planning, 28(9), 58-69
[17] Basu, A. K., Byrne, A., & Drew, M. E. (2011). Dynamic Lifecycle Strategies for Target Date Retirement Funds. Journal of Portfolio Management, 37(2), 83-96
[18]Blanchett, D. M. (2014). Exploring the Risk of Ruin: A Simulation-Based Analysis of Retirement Strategies. Journal of Financial Planning, 27(7), 48-59
[19]Kitces, M. E. (2014). Raising More Risk in Retirement Portfolios. Journal of Financial Planning, 27(7), 40-47
