When Bucketing Has an Edge Over Fixed Asset Allocation

Bucketing can have an important advantage over Fixed Asset Allocation (FAA) when a retiree has both a low withdrawal rate and a low risk tolerance.

Consider a retiree withdrawing only 2% of their portfolio each year. Because they have low risk tolerance, an FAA approach may lead them to hold a relatively high percentage in bonds. The problem is that FAA generally determines the asset allocation primarily from the retiree's risk tolerance, not from the withdrawal rate.

So whether the retiree withdraws 2% or 5%, a similar risk tolerance could produce a similar bond allocation. That can unnecessarily reduce the portfolio's growth potential and, ultimately, the legacy.

Bucketing looks at the problem differently.

The retiree can express their risk tolerance by deciding how many years of expenses they want protected in a Safety Bucket. They might choose five years, seven years, or even ten years.

But the Safety Bucket is based on expenses, not a fixed percentage of the portfolio.

That distinction becomes extremely important when the withdrawal rate is low.

If a retiree withdraws only 2% of their portfolio annually, even ten years of expenses represents only about 20% of the portfolio. So the retiree can choose a very conservative level of protection—ten years of expenses—without necessarily putting most of the portfolio into low-growth assets.

With FAA, the same retiree might instead hold a much larger bond allocation simply because they are uncomfortable with portfolio declines.

This is the fundamental difference:

FAA asks: "What percentage of my portfolio should be in safe assets?"

Bucketing asks: "How many years of my future expenses should already be protected?"

The first approach is primarily driven by risk tolerance. The second combines risk tolerance with the withdrawal rate.

That gives bucketing an interesting advantage for conservative retirees with low withdrawal rates: they can have a high level of protection without necessarily having a high allocation to conservative assets.

There is also a psychological benefit. FAA makes retirees think about risk in terms of percentages and portfolio declines. Bucketing shifts their attention to something much more tangible:

"How many years of my future spending are already covered?"

That may be a better way to express conservatism in retirement.

If you want to see how this works in practice, Cherishbuckets.com lets you model your retirement portfolio using a bucket-based approach and see how much of your future spending can be protected.