HOW NOT TO RUN OUT OF RETIREMENT MONEY
One of the hottest issues in financial-planning circles is how to make sure retirees don’t run out of money before they die. As more and more baby boomers hit retirement, and with interest rates at record low levels, the question is how can retirees generate the income they need to meet their expenses.
I’d like to focus on a popular strategy used by financial advisors: the bucket strategy. This strategy became mainstreamed after the book Buckets of Money: The Ultimate Guide to Income for Life by Ray Lucia became a best-seller.
This is not a review of the book. I liked the book and have used a variation of the strategy for my clients for many years.
Conventional wisdom
Common financial-planning wisdom says that to generate your desired retirement income you need to withdraw 4 percent from your portfolio each year. Let’s say at retirement you have saved $400,000. Taking into account pensions, social security, etc., you need another $16,000 to supplement your income. The common wisdom would say invest 60% of you money in stocks and 40% in bonds, and based on historical data this will generate the needed $16,000. The problem with this strategy is that what may have been true 30 years ago, is irrelevant today.
Financial advisers love to trot out data and use fancy computer simulations that say based on decades of data and running over 1,000 simulations, if you follow the above-mentioned allocation (60/40) you will have more than enough money to live out your life. The problem is that 30 years ago interest rates were double digits, and today they are close to zero. In addition, these models use an 11% annual return on stocks as a given. Over the last 13 years, stock-market returns have been nowhere near 11% annually.
Due to today’s investing climate, the old-school conventional wisdom has become very problematic. It’s very questionable whether retirees will be able to achieve their goals by following the old strategy. This has led advisers to look for new ways to help their clients generate the income needed.
Fill your buckets
The bucket strategy calls for investors to divide their money into three buckets: a short-term liquid bucket; a slightly higher-yielding mid-term bucket; and a more aggressive long-term bucket. Keep in mind that there are many versions to the strategy.
When starting the strategy, take a look at current market conditions and then set up the buckets. Most variations call for each bucket lasting 10 years. Based on current conditions, I would say investors will be better served to cut the first bucket down to five years, and add the remaining years to the middle bucket.
Let’s go back to our example based on a $400,000 portfolio and a 65-year-old freshly retired individual. The investor would take $80,000 in the first bucket and invest it in very liquid, very safe investments like CDs, government bonds (inflation protected) and highly rated corporate bonds. It would be set up so that each year $16,000 becomes free. Any money left after five years would be transferred to bucket number 2.
The next bucket would have $240,000 to start with. It again would be invested so that $16,000 comes due every year for the next 15 years. Here a combination of highly rated corporate bonds, hi-yield bonds, international bonds, preferred stocks and government bonds would be used. The recent market rout has made preferred stocks and foreign bonds much more attractive. The extra income generated from these investments should help keep the value of the money versus inflation and leave over money to be invested in the third bucket.
The third bucket is the growth bucket. Here you have at least $80,000 that has been invested for 20 years before being tapped. Using a dividend-growth strategy and a mix of international stocks has the potential, over 20 years, to appreciate significantly. Keep in mind that international stocks, especially those in emerging markets, have gotten hammered, again creating an intriguing entry point for long-term investors. A 3.5% annual return will basically double the money ($160,000), and the hope is that after 20 years the market should do better than 3.5%. Even if it doesn’t, you will have 10 years of money to draw down.
You have now made it to 95 years old. We should all merit to live 120 years, but for financial planners, making it to 95 is considered a success. This is a very brief synopsis of the strategy, so speak with your financial adviser to see whether the bucket approach is right for you. But remember, past performance is not a reliable indicator of future results.
The information contained in this article reflects the opinion of the author and not necessarily the opinion of Portfolio Resources Group, Inc. or its affiliates.
Aaron Katsman is author of the book Retirement GPS: How to Navigate Your Way to A Secure Financial Future with Global Investing (McGraw-Hill), and is a licensed financial professional both in the United States and Israel, and helps people who open investment accounts in the United States. Securities are offered through Portfolio Resources Group, Inc. (www.prginc.net). Member FINRA, SIPC, MSRB, SIFMA. For more information, visit www.aaronkatsman.com or email aaron@lighthousecapital.co.il.
