How Well Does the Bucket Approach to Retirement Planning Work in Practice?

On The Long View this week, we’re turning the tables and interviewing Christine Benz, director of personal finance and retirement planning for Morningstar, about her new book, How to Retire: 20 Lessons for a Happy, Successful, and Wealthy Retirement.

Here are a few excerpts from Benz’s conversation with Dan Lefkovitz and Amy Arnott.

How Well Does the Bucket Approach to Retirement Planning Work in Practice?

Dan Lefkovitz: In terms of your own work, Christine, you’re a big proponent of the Bucket approach to retirement planning. It might be good for you to explain briefly what that is. But curious if any of the researchers have looked into how well it works in practice?

Christine Benz: Yeah, the Bucket approach, I always credit to Harold Evensky, who is a financial planner and financial-planning professor. And when I initially went down this rabbit hole of trying to learn about retirement planning, it was in a period when yields were very, very low. So, the old strategy of trying to subsist off of current income just wasn’t cutting it for most retirees. So, I remember talking to Harold one day. And by the way, that’s not a great way to pull cash flows from a portfolio anyway. But I was talking to Harold and asking him about, “How do you do it with your clients, given that yields don’t support a livable income stream and so forth?” And he said, “I just use this cash bucket that covers a couple of years’ worth of portfolio withdrawals. And then I manage a total return portfolio with that cash bucket bolted on.” And his basic finding in working with clients was that having the cash to pull from for their living expenses, especially during some sort of a down-market environment, just gave them a ton of peace of mind with the plan. They were less inclined to micromanage what he was doing with the long-term portfolio because they knew that their near-term cash flow needs were set aside in that cash position. And he also noted that it just gave them peace of mind to plan things; that they knew they could still take their family on the cruise that they had been planning next year, even if the market was down.

So, I’m listening to him and I’m thinking, well, if someone like this who really studies the investment piece of this, also finds that this is behaviorally sound, this seems like the kind of thing we should be talking about. So, I became an avid proponent of the Bucket approach. I found in many years in talking to groups of retirees that it really resonates with them as something that’s really intuitive, that it’s a way to think about structuring an in-retirement portfolio to support your cash flows. So, the typical Bucket structure that I use is a three-bucket structure where you have a couple of years of portfolio withdrawals in cash and then maybe another five to eight years’ worth of portfolio withdrawals in high-quality fixed-income investments, and then the rest of the portfolio can go into equities. So, with those first two buckets, you’ve built yourself something like seven to 10 years’ worth of portfolio cash flows in relatively safe investments. They’re not going to go down and stay down for 10 years. If that bucket too hits trouble, it probably might have a little bit of a hiccup, but it might recover within a few years. So that’s the basic idea in play with the Bucket structure.

In terms of the pushback, it’s interesting. I was hearing a lot more pushback prior to 2022, especially the main reservation about this Bucket system is that holding cash as an ongoing component of the portfolio, well it’ll drag on the portfolio’s return, right? There’s an opportunity cost. But it seems like 2022 shut everyone up on that front, where when stocks and bonds declined at the same time, having that liquidity bucket, I think, just made a world of sense. And of course, 2022 was a pretty unusual market, but I have heard fewer complaints about the Bucket strategy and about the opportunity cost associated with that cash bucket in particular since 2022.

Is the Bucket Strategy to Retirement Planning a Flawed Approach?

Amy Arnott: You mentioned there has been some pushback about the whole Bucket approach. And there was an article that Rob Berger wrote in Forbes where he called the Bucket strategy fundamentally flawed. And his argument, I think, is that you really only need one diversified portfolio where you still have exposure to a variety of different asset classes, including stocks, intermediate-term Treasuries, and maybe cash. But you’re not necessarily dividing things into three buckets, but instead you are looking at which asset class performed best in a given year and then pulling withdrawals from that area. So how do you respond to that type of criticism?

Benz: Yeah, I see it. And I think Rob makes some valuable contributions. He is part of our Bogleheads community, and he does some great work. And to be honest, Harold Evensky really reaches the same conclusion as well that his thought was cash plus this diversified portfolio. Any more buckets than that, you’re probably getting a little carried away. The reason I like to at least use three buckets as an illustration tool is that I think it does help illustrate the logic of, here’s why we are setting aside X percentage of the portfolio in safer assets. And we’re stair-stepping that component of the portfolio by risk level. So, your first line reserves would be your cash. Your next line reserves would then be on into Bucket 2 where perhaps you would want to sell short-term bonds if your cash bucket were exhausted. But I just find it to be a helpful illustrative educational tool more than anything else. I feel like it’s a good way to understand asset allocation, which otherwise can seem terribly black boxy. And I would also say, Amy, I think sometimes people do have the misconception that you need to have separate accounts for each of these buckets or something like that. No, that’s really just a way for understanding the accounts that you have in your portfolio.

How a Fourth Bucket Can Help with Long-Term Care in Retirement

Lefkovitz: You’ve also talked about a fourth bucket to cover potential costs for long-term care. Can you talk about that?

Benz: So, I was just saying, don’t get carried away with too many buckets. And I do like the idea of perhaps a fourth bucket where you have your, “I don’t know what’s going to happen” bucket, which is how I would see that fourth bucket where if you have uninsured long-term-care expenses, or if you live to be 105, or perhaps it’s your bequest bucket. And so, the idea is if you have outlays that you may need to address later in life, but you don’t know specifically how your life will play out, that’s the virtue of having that siloed fourth bucket that’s effectively segregated from your spendable portfolio. To me, there’s just a healthy mental accounting thing there that could provide someone some peace of mind if they have that silo of assets, and the idea is while this is for this, this, or this use later in my life, and I’m not going to touch it during my own lifetime, or I will only touch it in a worst-case scenario—I think it’s just an attractive way to mentally frame up how you’re using each component of the portfolio.