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Here’s a different kind of “bucket list” for you. It’s not exactly the things you want to do, but it may be related to them. What it does do, however, is make it easier for you to manage your retirement investments.
But be careful. If you’ve immersed yourself too much into financial terminology, this concept might shock you. It’s definitely not your father’s (or grandfather’s) style of investing.
“The bucket approach segments your assets into different pools that either align with goals or time,” says J. Womack, Managing Director of Investment Products and Personalization for SEI’s Advisor Business in Oaks, Pennsylvania. “Where ‘buckets’ align with goals, it’s a reinforcement of the behavioral financial concept of mental accounting. You think about your money in separate buckets, so you create a direct alignment between those mental buckets and actual buckets (i.e., accounts). That level of transparency can be helpful when managing your investment portfolio through volatility because you can ‘see’ the assets associated with meeting various goals.”
Traditionally, institutions like pension plans and endowments have used the “total return” approach. A strong consensus for using this as the preferred approach developed more than half a century ago when new financial theories emerged from the (then) latest research. This research suggested assets could be allocated within the total investment portfolio to produce optimal returns.
“The bucket approach is significantly different than traditional asset allocation,” says Matthew Grishman, Principal & Wealth Advisor at Gebhardt Group, Inc. in Roseville, California. “Traditional asset allocation takes a 30,000-foot view of all your assets and recommends a diversification strategy that applies to all your assets at once; it also requires a long-term time horizon for that overall allocation to be successful. This traditional approach is based on a 1950’s academic theory called ‘Modern Portfolio Theory’ (‘MPT’). When Harry Markowitz and friends created MPT, it was at a time when most individuals had pensions and did not need to shoulder the responsibility of providing for their own retirement. In the 1950s, the majority of stock investors were institutions, big endowments, pension pools and the ultra-wealthy; entities that did not necessarily have a specific time frame for when these assets were required to replace traditional forms of working income.”
This old-style asset allocation approach still applies to those large institutions and continues to make sense. For individuals, on the other hand, fewer assets and shorter time frames require a different way of managing investments. That’s why the “assigned asset” (or “bucket”) method has grown increasingly popular. It’s really an extension of the trend towards “Goal-Oriented Targeting.”
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“This approach typically breaks an investor’s portfolio into ‘buckets’ that align to specific goals,” says Katie Hockenmaier, Partner, US Defined Contribution Research Director at Mercer in San Francisco. “The goals are typically anchored to liquidity needs. The most basic bucket approach is to have three buckets, each of which is structured from most conservative to least conservative. There are many variations on the bucket approach. Some individuals may have more than three buckets with additional buckets being ‘aspirational’ or for other known longer-term expenses.”
Dividing your portfolio into several buckets and assigning each bucket to a separate and distinct goal runs contrary to the usual asset allocation framework, where the entire portfolio is segmented into specific percentages of asset classes.
“A bucketing or segmented approach assigns specific dollars to specific timelines for use,” says Janet Walker, Owner and Advisor at GenWealth Financial Advisors in Bryant, Arkansas. “Rather than utilizing a traditional 60/40 stock/bond split and just taking a withdrawal from it, it is important to invest dollars relative to the timeline when you will need them. That timeline, in turn, determines the amount of risk the investor should take and how those dollars are allocated to specific investment vehicles. If you need income in 5 years compared to 25 years, those dollars can be invested very differently using the bucketing approach.”
There are many ways to employ the Assigned Assets method of investing. For example, you may have a specific objective related to purchasing big ticket items (like homes, cars and major capital improvements), events (like weddings, trips and other milestone occasions) and any other one-time happening. Each bucket would be independently invested for a particular goal-oriented target.
Still another way to use the bucket approach is to assign buckets for specific risk objectives. Unlike the previous example, these buckets would be linked according to their risk factor. Within this hierarchy of buckets, assets spill down over time from the riskiest buckets to the least risky buckets.
“Have you ever been at a wedding or fancy party and seen the champagne towers where the champagne is poured at the top of the tower then overflows into the glasses below and cascades down to the bottom?” says David Morgan, Managing Partner at The High Net Worth Advisory Group LLC in Naples, Florida. “That is similar to the bucket approach to investing.”
For example, using this framework, you can assign each bucket a defined time period.
Richard Freeman, Senior Director and Wealth Advisor for Round Table Wealth Management in New York City says, “Under this method, a typical bucket model looks like this:
- Bucket 1: contains cash and cash equivalents (low risk and volatility) and is used to meet near-term expenses in retirement.
- Bucket 2: contains fixed-income (medium risk and volatility) and is positioned to meet intermediate-term expenses in retirement.
- Bucket 3: contains equities (higher risk and volatility) and is positioned to cover longer-term expenses in retirement.
As retirement spending progresses, funds are moved from bucket three to two to one.”
Why do you want to consider using the bucket method rather than the traditional asset allocation approach?
“You can visualize buckets,” says Marc Scudillo, Managing Officer of EisnerAmper Wealth Management and Corporate Benefits LLC in Iselin, New Jersey. “This makes it easier to understand the approach of seeing money flowing from one bucket to the next and also having the peace of mind that your cash flow needs are going to be met regardless of the market downturn.”
Just as Elvis Presley no longer tops the pop charts, maybe it’s time you revisit how you look at your investment portfolio. You may find reframing it into identifiable and practical buckets can ease your worries.
“The bucket approach is easier to understand because it aligns your money with your planned lifestyle,” says Grishman. “Traditional asset allocation is a 70-year-old academic theory that can easily get bogged down in industry jargon. Plus, most people have a difficult time deciding what they’re having for dinner tonight, let alone trying to wrap their brains around a 30-to-40-year asset allocation strategy. The bucket approach makes investing simpler. You may have a hard time understanding things like standard deviation, measuring beta, correlation among asset classes, etc. On the other hand, you can easily understand the concept of hand-drawn buckets that illustrate taking no risk with money you need now; a little risk for the money you need soon; and more risk for the money you need later.”
Do you see now how adding “buckets” to your bucket list can make your retirement life much more comfortable and satisfying?
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