Should Retirees Reduce Their Bucket Size or Their Spending?

An interesting question for practitioners of the bucket approach is what should happen when a retiree's Monte Carlo results suggest that their chosen bucket size (years of expenses) and annual spending are unlikely to be sustainable.

The first reaction of many practitioners of the bucket approach is to reduce the bucket size. Doing so lowers the amount allocated to the safety bucket, increases the allocation to the growth bucket, and improves the portfolio's long-term return potential.

But there is another option that is rarely discussed: reduce spending instead.

Reducing spending can improve the Monte Carlo results while allowing the retiree to maintain the same level of protection. The retiree gives up some lifestyle but retains the psychological comfort of knowing that a larger portion of future expenses is protected.

Some advisors and retirees may find this suggestion surprising. Yet this is exactly how retirement planning works under a fixed asset allocation (FAA).

When a retiree using FAA has an unacceptably low probability of success, advisors generally do not recommend making the portfolio more aggressive. Instead, they preserve the retiree's chosen asset allocation—which reflects their risk tolerance—and recommend reducing spending.

Why, then, is the reaction so different under the bucket approach?

One possible explanation is that the asset allocation used in FAA is usually based on a carefully designed risk-tolerance questionnaire. The retiree's allocation is therefore viewed as a deliberate expression of their willingness to take risk, making it less likely that advisors will suggest changing it.

In contrast, the number of years of expenses held in the safety bucket is often chosen without a comparable assessment of the retiree's comfort with risk. As a result, advisors may assume that the chosen bucket size is arbitrary or unnecessarily conservative, leading to the instinctive recommendation to reduce it.

There is merit to both perspectives. Without a structured process, the chosen bucket size may indeed be more conservative than necessary. On the other hand, it may accurately reflect the retiree's comfort with risk and provide meaningful peace of mind.

Perhaps the best long-term solution is not to debate whether retirees should reduce their bucket size or their spending, but to develop a risk-tolerance questionnaire specifically for the bucket approach. Just as FAA relies on questionnaires to determine an appropriate asset allocation, the bucket approach could use a similar framework to determine an appropriate level of protection.

Doing so would address two important issues. It would help retirees remain emotionally committed to their investment strategy while ensuring that their spending is aligned with what their portfolio can sustainably support.