retirement

Buckets or Pies: Which Retirement Strategy Works for You?

The standard investing methods have their virtues (and shortcomings), but the key is to apply them thoughtfully and with some flexibility.

As fee-only financial planners, the overriding concern we hear from people approaching retirement is “will I have enough to live on?” Followed closely by “how can you make my money grow, without exposing it to a lot of risk?” After the dramatic economic downturn in 2008, even the most confident investors can become a bit skittish when they think about relying on their investments for the next 20 or 30 years.

I get concerned when I look at the financial planning industry and the simplistic solutions that it typically offers people.

It seems that a majority of investment firms and advisers default to the traditional methods of statistical backtesting, mean-variance optimization and plotting portfolios along the “efficient frontier” in an attempt to deliver acceptable performance (and if these terms mean nothing to you, don’t worry, they don’t mean a lot to the people who spout their virtues either).

Now, I’m not saying that there isn’t validity in some of these methods. It is important for competent advisers to understand them, and to also understand their shortcomings.

While any or all of these tools may work well for people in their earning and investing years, they may set up some individuals for an emotional and anxiety-ridden retirement if they are in the hands of an inexperienced adviser.

While the traditional pie-chart approach to investing has its virtues, such as being able to see at a glance how well a portfolio is diversified, it typically is used as data to develop an expected rate of return, and to evaluate how closely it matches an “efficient” portfolio, a la the following image (to give you an idea of how prevalent this theory is, it took me about two seconds to find this on Google):

iStockphoto

And here's another view:

iStockphoto

There are myriad problems with an over-reliance on this approach, not the least of which is that in any given time frame, the assumptions in these charts could get upended. How do you think this last chart would have looked in the 1970s and ’80s when interest rates approached 14%, and the historical risk on bonds was similar (hint: a lot different than this chart, considering bonds’ returns were higher than stocks’, just as they were in the middle of the 2000s). How prudent would it have been to tightfistedly hang on to a set asset-allocation policy back then?

This problematic thinking is not a concern for every investor, as some have adequate sources of outside income (pensions, state or government retirement systems, etc.) or significantly more assets than they could ever use in their lifetimes. But for the person who has just enough of a portfolio to supplement his or her retirement in addition to Social Security, it may be an approach that keeps them up at night.

For this client, we recommend the use of a “bucket” strategy. A bucket strategy basically breaks down the projected income needs of the client into segments with varying time frames, depending on his or her expected future goals and needs. Different risk and return assumptions are assigned to each segment relative to the need to be more conservative or aggressive. So a person my have a portfolio with four buckets assigned to it — cash and very conservative investments in the first bucket to get them through the first X years of retirement, followed by a balanced bucket, a moderate bucket and an aggressive bucket.

Now, we can adjust the investment vehicles in these buckets based on economic conditions and forecasts, and also move assets between buckets as needed.

The idea is to commit only the assets that are needed in the near-term to more stable investments, and to reserve more aggressive holdings for later years.

Sample page from a bucket retirement income strategy report:

iStockphoto

In addition to being a very practical approach, the bucket strategy tends to make sense to people who don’t spend a lot of time in the financial markets, while also putting their minds at ease. Obviously, you could take this and develop an overall rate of return needed for the portfolio, but there can be a world of difference in concept and understanding. Also, as neat as this looks, it can get a little challenging when applying the strategy across taxable and tax-preferred accounts. One of our goals is to maximize the tax advantages of our retiree client portfolios, so we have to be careful about which assets go where.

In summary, we’ve found that both approaches work, depending on the client’s circumstances, and as long as periodic evaluations and adjustments are made. There are, however, certain indicators that we look for when recommending one strategy over another, as when it comes to retirement income planning, one size does not fit all.

Doug Kinsey is a partner in Artifex Financial Group, a fee-only financial planning and investment management firm based in Dayton, Ohio.

About the Author

Doug Kinsey CFP®, CIMA®, AIFA®

Partner, Artifex Financial Group

Doug Kinsey is a partner in Artifex Financial Group, a fee-only financial planning and investment management firm based in Dayton, Ohio.

Doug has over 25 years experience in financial services, and has been a CFP Certificant since 1999. Additionally, he holds the Accredited Investment Fiduciary and Accredited Investment Fiduciary Analyst certifications as well as Certified Investment Management Analyst.  He is a graduate of The Ohio State University and also the University of Chicago Booth School of Business Investment Management Education Program.

Most Popular

Planning to Sell Your Home in Retirement? Downsize Costs Along With Space
Budgeting

Planning to Sell Your Home in Retirement? Downsize Costs Along With Space

In this hot real estate market, consider the costs of buying and selling a house along with the expenses associated with your new digs.
November 13, 2020
What Biden Will Do: 24 Policy Plays to Expect From the Next Administration
Politics

What Biden Will Do: 24 Policy Plays to Expect From the Next Administration

The Kiplinger Letter forecasts President-Elect Joe Biden’s biggest priorities -- and the likelihood of progress on them.
November 19, 2020
The 13 Best Healthcare Stocks to Buy for 2021
Kiplinger's Investing Outlook

The 13 Best Healthcare Stocks to Buy for 2021

Most of the best healthcare stocks for 2021 will have some sort of ties to COVID, whether it's producing a vaccine or cure, or benefiting from the vir…
November 20, 2020

Recommended

13 States That Tax Social Security Benefits
social security

13 States That Tax Social Security Benefits

You may have dreamed of a tax-free retirement, but if you live in these 13 states, your Social Security benefits are subject to a state tax. That's on…
December 2, 2020
18 States With Scary Death Taxes
inheritance

18 States With Scary Death Taxes

Federal estate taxes are no longer a problem for all but the extremely wealthy, but several states have their own estates taxes and inheritances taxes…
December 2, 2020
Where to Invest in 2021
Economic Forecasts

Where to Invest in 2021

With the election in the rearview mirror, investors can turn their full attention to the economic recovery and progress on the pandemic.
November 28, 2020
The Best T. Rowe Price Funds for 401(k) Retirement Savers
Kiplinger's Investing Outlook

The Best T. Rowe Price Funds for 401(k) Retirement Savers

A dozen T. Rowe Price mutual funds also have a place among the nation's most popular 401(k) retirement products. Find out which funds belong in your r…
November 27, 2020