Keeping Your Cash Flow in Retirement: The “Three Bucket” Approach
No investment or capital management tactic will apply today and during your retirement. Still, careful strategizing today can build a flexible foundation that’s adaptable no matter your life circumstances. At Assurance Wealth Management, we like to employ a Three Bucket Strategy with our clients. This strategy is a framework, rather than a prescriptive set of rules, and a well-developed Three Bucket Strategy is easily modified as you age out of the workforce and into retirement.
At its most basic, the strategy allocates your cash and capital across three buckets:
- Liquid: easily accessible cash you have constant access to, used for emergency expenses and similar costs. You can think of the liquid bucket as an emergency fund, of sorts, but it’s true function is more much all-encompassing.
- Income: this bucket consists of all your cash flow-producing assets, including planned income streams like Social Security. Ultimately, the income bucket should replace your day-to-day salary or wage as you enter retirement and begin budgeting.
- Growth: the growth bucket is more closely aligned with your typical brokerage or retirement investment account and should go as untouched as possible before retirement to maximize its growth potential. Even in retirement, you should maintain as large a growth allocation as possible to account for increased longevity and, if applicable, ensure you’re leaving a financial legacy for your children or family members.
Unplanned expenses and emergencies pop up more often than we’d all prefer, so it’s critical to maintain an easily accessible, liquid pool of cash to address these emergencies. You can call it an emergency fund, and many do, but we prefer “liquid bucket” as the term applies to a greater number of scenarios than just a broken-down car or surprise medical event.
The primary goal for your liquid bucket is capital preservation. You don’t want this bucket exposed to daily or even long-term market fluctuation – this capital needs to be accessible and steady. Essentially, you’re sacrificing gain for the comfort of a decent cash cushion to address unforeseen circumstances.
That doesn’t mean stuff a bunch of bills under your mattress, though. As we saw previously, inflation degrades cash’s value over time. So, ideally, you allocate your cash to short-term, stable, “safe” investments. Beyond cash in a checking account, these can include:
- High-yield savings accounts.
- Money market funds.
- Short-term Treasuries and certificates of deposit (CDs).
If you’re leaning towards the last category and want to squeeze additional yield from your liquid pool, carefully consider which fixed-income products you select. First, manage the maturity closely. Because you want easy access to capital, locking your funds in a 10-year CD or Treasury Note isn’t advisable – particularly when deciding on CDs, as these don’t always trade easily (or at all), and you may face a loss if you sell the CD on a secondary market before maturity.
For example, this six-month CD has zero market depth, meaning no buyers or sellers are interested in transacting the security. While you can, sometimes, request a bid from potential buyers, expect to sell at a discount for the convenience of “unlocking” the capital.
While Treasuries trade quickly on secondary markets, you should also consider the size of the investment. Sometimes, secondary market buyers demand a substantial minimum purchase. Here’s a snapshot of one secondary market listing:
For this four-week Treasury Bill, secondary buyers want a minimum transaction size of 50 T-Bills. That equates to $50,000 face value, and higher pricing for the asset demands greater transaction sizes – all the way up to $3 million. So, if you have $10,000 allocated to short-term Treasuries and need to liquidate quickly, you may be unable to offload the Treasuries or, if you request a bid, end up with less than initially invested.
For these reasons, it’s best to stick with very short maturities to balance the best yield with accessibility and liquidity. You can also explore laddering strategies, where you invest in a series of maturities to generate income while maintaining liquidity, but this advanced strategy generally demands a greater overall allocation to be worth the effort.
Income allocation and assets have greater diversity than most liquid bucket options and even include bankable income streams like Social Security, which aren’t considered investments. That’s why it’s important to project and plan for these income-producing sources within the specific bucket. Dividend stocks and longer-term bonds are usually the go-tos when considering income opportunities. Still, many future retirees overlook a handful of income opportunities, although they may provide 50% or more of a retiree’s consistent, recurring income.
As with any asset or opportunity, options depend mainly on your circumstances. We don’t recommend all options for all clients, but you can consider a range that includes:
Social Security benefits: it isn’t easy to project what your future Social Security income stream may be worth, particularly if you’re many years from retiring. Still, most ready to retire in the next 10 – 15 years should be able to bank on a foundation of $1,000 - $2,000 monthly that rises with inflation and remains generally unaffected by the wider market.
Ultimately, the typical American retiree relies on Social Security for 30% - 40% of their annual income – so Social Security should factor into your income projections if you’re nearing eligibility or retirement.
Social Security is a complex topic, and alternative cash flow strategies are available that include forgoing recurring income for an upfront lump sum. Remember, too, that spousal benefits can impact your own (and vice versa), so consultation that addresses your unique lifestyle qualities is usually best before pulling the trigger on any Social Security decisions.
Annuities: these financial products get a bad rap sometimes, but it’s typically due to unscrupulous salespeople hawking shadily structured assets rather than anything intrinsically wrong with annuities themselves. For some retirees, annuities are an ideal option to supplement your income bucket. Within income-based annuity options, retirees typically pick between one of two primary types:
- Single premium, immediate annuity. Retirees contribute a lump sum premium when using an immediate annuity and convert that payment into retirement income. Sometimes, you can elect to continue income payments to a beneficiary or spouse after the principal annuity holder passes. Annuity terms vary by provider, usually underwritten by an insurance firm, and variance includes maximum premium payment, number of terms, and integration with existing retirement accounts to manage tax burdens.
- Deferred annuity. Deferred annuity mechanics are more aligned with typical fixed-income investment options like bonds. When buying an annuity, the purchaser forks over a premium for the promise of income cash flow in the future. Different types of deferred annuities generate different and varied returns:
- Fixed annuitiesreturn the agreed-upon amount when the buyer pays the premium and signs the contracts.
- Indexed annuities return a rate based on an underlying market inde
- Variable annuities’ return depends on the annuity owner’s investment portfolio performance.
As you can likely tell, these three types have different risk profiles, with fixed annuities at the “low risk/low reward” end of the spectrum. In contrast, variable annuities reliant upon third-party investment performance are riskier with much greater potential return (or loss).
Annuities are a viable income bucket option for many prospective and current retirees. Because types and terms vary so much, though, and the annuity sales field tends to attract unscrupulous operations, working closely with a trusted wealth manager while considering annuity options before pulling the trigger is vital.
Most likely, your growth bucket comprises all the accounts and assets you’ve accrued over your lifetime. Your growth bucket is made up of brokerage accounts, 401(k) accounts, IRAs, employer-sponsored plans, and even your real estate assets. Within growth accounts, you’ve cultivated a range of stocks, bonds, ETFs, mutual funds, and other securities over time.
Because your growth bucket allocations are as unique as your fingerprints, there’s little use diving into every possibility or contingency. What’s useful, though, when considering income planning for retirement is how you adapt your growth bucket to your lifestyle.
Risk management is the primary driver of that adaptation, but many wealth managers or investment planners go about risk planning incorrectly. You’ll often see or get a generic risk profile questionnaire primarily based on your age and time of retirement. As you age or get closer, wealth managers generally cycle your growth allocation to “safer” assets like bonds and structured notes.
What should happen, though, is an evaluation of your growth bucket as a function of what you need in retirement. If you have a robust portfolio and well-managed liquid and income buckets and want to continue on an aggressive path within your growth bucket as part of a legacy plan, there’s an argument to be made those heavily weighting equities is the right move. For many wealth managers, that’s anathema – but a good, quality relationship is built on an intimate understanding of your financial position, current and future needs, and what you want. If your manager uses generic risk profiling tools or unthinkingly follows the classic “allocate your bond percentage by subtracting your age from 100,” you deserve better.
Maintaining the Best Bucket Possible
Ultimately, there’s no one-size-fits-all solution to allocating assets across your three buckets. And, practically speaking, what works today won’t necessarily be right tomorrow – meaning you must periodically and comprehensively review your buckets in line with your lifestyle changes and adapt them to your needs.
Ultimately, though, creating a foundation for the future using the Three Bucket Strategy sets you up for a fruitful retirement. The primary benefit of the strategy is its inherent flexibility and adaptability to your current and future life circumstances. Working with your wealth manager to establish a plan of action, using the Three Bucket Strategy, is a surefire way to begin getting comfortable with the realities of retirement.