There are many different approaches and strategies to retirement investing that may appeal to you. But how do you know if a certain strategy works for your situation?
When evaluating different approaches, consider how each strategy is constructed and determine if it fits your individual needs, resources, and risk tolerance. If you’ve ever been interested in what’s called a “bucket strategy,” you’re in luck: Morningstar has put together three specific bucket strategy examples for you to check out.
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If you’re not familiar with the pool strategy, it requires structuring your retirement assets into three pools based on longevity and when cash is needed.
The first group contains your cash, cash equivalents, and other liquid assets designed to be used in the early years of retirement. A medium-term category focuses primarily on bonds. A third group of long-term actions is designed to promote growth. As the cash reserve is depleted, medium-term assets are sold to replenish it, and long-term assets are liquidated to top up the medium-term reserve.
“The bucket approach to retirement portfolio planning is not designed to generate the best possible investment returns,” writes Christine Benz, director of personal finance and retirement planning at Morningstar. “It won’t, almost by definition. Instead, the bucket strategy is aimed at actual retirees, to help them get the cash flows they need, regardless of what’s happening with their long-term holdings.”
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Using the bucket strategy, Benz Created three model portfolios for various risk tolerances.All three approaches rely on exchange-traded funds (ETFs) held in tax-deferred accounts, with withdrawals used to cover some or all of a retiree’s living expenses. The risk of the portfolios ranges from aggressive to moderate and conservative.
Here’s how the three model portfolios compare based on how they allocate their assets between cash, bonds, and stocks:
Aggressive. Designed for a retirement expected to last more than 25 years, it is aimed at investors with a high risk capacity:
Cash: 8% of assets are held in cash during years 1 and 2 of retirement.
Captivity: 32% of assets are held in bonds during years 3 to 10 of retirement.
Stocks: 60% of assets are held in stock for year 11 and beyond.
Moderate. Designed for a retirement expected to last between 15 and 25 years, it is aimed at investors with a moderate risk appetite.
Cash: 10% for years 1 and 2 of retirement
Captivity: 40% during years 3 to 10 of retirement
Stocks: 50% for year 11 and beyond.
Conservative. Designed for a retirement expected to last less than 20 years, it is aimed at investors with low risk appetite.
Cash: 40% for years 1 and 2 of retirement
Captivity: 48% during years 3 to 10 of retirement
Stocks: 12% for year 11 and beyond
In terms of customizing the strategy, a lot will depend on the level of spending in retirement, but the focus is on cash as it serves as a hedge against market shocks. A low-spending investor who could withdraw just 3% to start could fund an aggressive portfolio with just 6% of his holdings in cash. Typically, however, retirees tend to spend more in the early years of retirement and then reduce their spending as they reach their retirement goals and age. A financial advisor can help you determine the appropriate asset allocation based on your goals and financial profile.
Conclusion
The bucket strategy is an intuitive and relatively simple approach to allocating your assets between cash, bonds, and stocks in retirement. Morningstar has three portfolio asset allocation models you can use based on your risk tolerance and how long you expect to live in retirement.
Tips for managing your portfolio
A financial advisor can help you select investments, rebalance your holdings when necessary, and manage your tax liability. Finding a financial advisor doesn’t have to be difficult. SmartAsset’s free tool connects you with up to three vetted financial advisors serving your area, and you can interview your matched advisors at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now. You can also read SmartAsset reviews.
SmartAsset’s asset allocation calculator can also help you determine how to allocate your assets between stocks, bonds, and cash based on your risk tolerance.
While rebalancing can bring your portfolio back into line with your risk tolerance, be aware of the costs. Can you cover the fees you might have to pay upfront to buy a new asset or sell current investments? It is also wise to examine the expense ratio of the securities you are interested in. This number indicates the percentage of your assets that are used to cover management fees.
Keep an emergency fund on hand in case you have unexpected expenses. An emergency fund should be liquid, in an account that is not at risk of significant fluctuations like the stock market. The downside is that inflation can erode the value of liquid cash. But a high-interest account allows you to earn compound interest. Compare savings accounts at these banks.
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