When is a 3-Bucket Model Really Better Than a 2-Bucket Model?

A 2-bucket retirement model typically consists of a Safety Bucket and a Growth Bucket, with the Growth Bucket periodically refilling the Safety Bucket.

But there are two fundamentally different ways to structure that Growth Bucket.

The first is to earmark the bonds within the Growth Bucket for future refills, while allowing the equity portion to grow freely. The second is to maintain a fixed allocation—for example, 60% equities and 40% bonds—and make prorated distributions from the Growth Bucket into the Safety Bucket.

The first approach has a fundamental modeling problem.

If all the bonds are earmarked for future Safety Bucket refills while equities have free rein to grow, the allocation of the Growth Bucket will change continually. It might be 60/40 one year, 70/30 the next, and eventually 80/20. Consequently, the expected return of the Growth Bucket also changes over time, making it considerably harder to model in a financial plan.

If the retiree or advisor wants the bonds specifically earmarked for future spending, it is cleaner to create a third, Income Bucket. The bonds can reside there and refill the Safety Bucket as needed. The Growth Bucket can then remain a true growth portfolio, making its behavior much easier to model.

So the meaningful choice is really between a 2-bucket model with prorated distributions and a 3-bucket model. A 2-bucket model with earmarked bonds can be considerably harder to sustain and plan around.

There is also another situation where three buckets can be superior: highly variable or irregular spending.

Suppose a retiree has unusually large expenses in some years and very little spending in others. A fixed 60/40 Growth Bucket may then hold too many or too few bonds relative to what is actually needed for future Safety Bucket refills. The appropriate refill amount changes with the spending pattern, while the portfolio allocation does not.

A 3-bucket structure can solve this neatly. The Income Bucket can contain just enough bonds to fund the expected Safety Bucket requirements, while the Growth Bucket remains invested primarily in equities.

In other words, three buckets aren't inherently better than two. But when spending is irregular or bonds need to be explicitly earmarked for near-term spending, separating the income function from the growth function can make the strategy substantially cleaner to manage—and much easier to model.