Retirement Bucket Strategy: Meaning, Investment Options & Other Details

Having a financial plan is helpful at every stage of life, more so when one no longer has a steady income. Retirement is said to be the golden period of a person’s life when they can pursue their hobbies and relax without any worries. However, to make sure one lives stress-free during this time, it is important to start planning for it as early as possible. 

A retirement bucket strategy can help a person prepare effective financial plans for retirement. 

Understanding the Retirement Bucket Strategy

A retirement bucket strategy is a financial plan that helps people to build a corpus that provides income after retirement. The underlying concept of this strategy is to have 3 ‘buckets’ of investment based on the time horizon when the funds are required.

Usually, this strategy involves dividing one’s investment into 3 sections- short-term, mid-term and long-term based on your financial goals. Each bucket is filled with different types of assets with varying levels of risk. This helps retired individuals fulfil their income needs in different phases of their post-retirement lives. 

Many people tend to make mistakes when deciding on the monthly income they need to invest. Underestimating future medical expenses, procrastinating about building a retirement corpus and not diversifying their investments are other serious but common mistakes. 

A Detailed Look at the Three Bucket Strategy 

American financial advisor Harold Evensky developed the bucket strategy for retirement in the 1980s. Originally, there were only 2 buckets, but later, Evensky introduced a third bucket for an extra security layer. Now, let us take a detailed look at it:

• Emergency Savings for Short-Term

The first bucket in this strategy is reserved for meeting living expenses, and short-term financial needs, such as medical emergencies, especially during the initial 3 – 4 years of retirement. The funds in this bucket are mostly in the form of assets that a person can easily liquidate, such as liquid funds, fixed deposits, and savings accounts.

The portfolio for this bucket should be highly conservative as it will pay for your immediate expenses. One must remember that emergencies can strike any time, and you may have to spend most of the retirement corpus to deal with it. 

So, having a special reserve of money to address such needs during the initial retirement years will be helpful. This bucket effectively covers the income gaps in a person’s early retirement years.

Also Read: A Simple Guide to Your Retirement Budget

• Medium-term holdings 

The second bucket in the retirement bucket strategy comprises funds that help investors fulfil their medium-term goals, such as exploring their hobbies or going on a world tour. The investments in this bucket should be able to cover expenses for a minimum of 5 to 10 years. 

Investments in this holding tend to offer modest returns that help in steady growth. These assets can carry moderate risks but not high risks. Debt funds like short-duration funds and high-quality corporate bond funds can be suitable here.

• Long-term or high-risk holdings 

This strategy’s third and last bucket is for long-term investments that help the investor earn maximum inflation-adjusted returns. This bucket effectively generates a stream of income for a retired person. Furthermore, it also holds the capability to refill the first and second buckets. 

For long-term needs, one needs the high growth potential of equity investments. Bluechip funds and multi-asset funds can be suitable investments in this retirement bucket. 

Read More: Top 10 Multi Asset Allocation Funds to Consider in 2022

List of Investments Suitable for Retirement Bucket Strategy 

Let us take a look at the investment options for each bucket:

• Bucket 1

Listed below are some of the investment options for the initial four years of retirement: 

1. Fixed deposits at banks- An investor deposits a lump sum amount at a bank for a fixed tenure at a pre-decided interest rate. After the tenure, the account holder receives the entire investment amount and a fixed interest.
2. Liquid mutual funds- These are highly liquid mutual fund securities. The maturity period of the securities that these debt funds invest in is 91 days.
3. Ultra-short duration funds- These mutual funds invest in money market instruments and debt securities. The Macaulay duration (weighted average time to receive a fund’s cash flow) of the entire portfolio is between 3 to 6 months. 
4. Senior Citizens Savings Scheme (SCSS)- It is a savings instrument for senior citizens, backed by the Government of India (GoI). It ensures a steady and secure source of income for people after they retire.
5. Pradhan Mantri Vaya Vandana Yojana (PMVVY)- PMVVY is also a GoI-backed pension scheme that also works as an insurance policy. It provides an alternative income source to the senior citizens of India.
6. Systematic Withdrawal Plan (SWP)- If a person invests a lump sum amount in a mutual fund, an SWP allows them to withdraw a specified amount from it at regular intervals.

Also Read: A Simple Guide to Making Your Retirement Budget

• Bucket 2

Listed below are the suitable investment options that would address the financial needs for a minimum of 5 to 7 years after retirement: 

1. Hybrid funds– These mutual funds invest in a mix of equity and debt securities. Hybrid funds can be classified into several categories. These include conservative hybrid funds, multi-asset allocation funds and aggressive hybrid funds. 
2. Balanced advantage mutual funds- This is a particular type of hybrid fund which is free to allocate assets dynamically. These funds invest in equity or debt instruments but change their asset allocation depending on the market conditions.
3. Short-duration mutual funds: These debt funds invest in fixed-income securities with a short-term Macaulay duration of 1 – 3 years.

Also Read: What are Fixed Annuities & How Do They Work?

• Bucket 3 

Listed below are suitable options for long-term financial needs:

1. Large-cap funds- These are open-ended equity funds that invest 80% of their total assets in equity or equity-linked instruments of large-cap companies. 
2. Multi-cap funds- These are open-ended equity schemes that invest across large-cap, mid-cap and small-cap companies. It essentially invests a minimum of 25% of its total assets in each category of stock.
3. Flexi-cap funds- These are open-ended mutual funds that invest in stocks across large-cap, mid-cap and small-cap market capitalisation. While they seem similar to multi-cap funds, these funds have to invest only a minimum of 65% of their total assets in equity or equity-related instruments.

Once the buckets have been created, then periodic review and rebalance must be done to ensure that risk is being managed.

Bucket Strategy before Retirement 

So far, we have discussed how a person should fill up these buckets after they retire. 

However, according to experts, people need to start formulating their financial plans for retirement as soon as they start working. So, it is advisable to start implementing the 3 bucket retirement strategy while being employed. Further, investing early enables the money to grow effectively due to the power of compounding.

Listed below are a few important points that might help in building the strategy: 

• When an investor decides to use a retirement bucket strategy, he or she should focus on filling up the first bucket that covers expenses of the initial 4 years. 
• After one has completed filling up the first bucket, he or she should proceed to fill up the second and third buckets. Investors should note that the time left for retirement determines the investment amount. 
• If an investor has a lot of time left for retirement, he should invest more money in the third bucket, which is for high-risk investments over a long investment horizon. 
• Another important factor that people need to remember is that they must evaluate these buckets regularly and rebalance their investments according to their financial goals. Furthermore, they can also change their contributions as per their priorities.
• A retirement bucket strategy enables a person to have a substantial corpus for retirement. Following a customised bucket strategy that caters to an investor’s risk appetite and income needs is more important. This is an overall effective strategy to allocate assets across multiple timelines. Moreover, one can always rebalance their investments if needed. 

Once an investor understands any strategy, they must also have knowledge about the merits and demerits of the same to make a more rational investment decision.

Benefits of Retirement Bucket Strategy 

Listed below are some of the benefits of following the bucket strategy for retirement: 

• The retirement bucket strategy helps a person have a steady source of income after retirement. In addition, it ensures adequate liquidity in one’s investments to deal with small emergencies.
• The most important advantage of the three buckets is that they cater to different levels of growth. As a result, investors can use a particular segment for their liquidation needs whenever the need arises.
• Even though the retirement bucket strategy may seem to be overwhelming at first glance, it is quite simple to implement. Additionally, a wide range of investment options is available for each of the 3 buckets.
• A retirement bucket strategy also helps to achieve portfolio diversification as the investments are spread across various asset classes. This is quite helpful in maintaining a balance between risks and rewards.

Demerits of Retirement Bucket Strategy 

Though this strategy has numerous advantages, investors need to be aware of some of its demerits as well:

• People need to know that a retirement bucket strategy management is inconvenient, especially if a person wishes to manage it independently. They must regularly track and rebalance the portfolio according to the prevailing situation. Knowledge of the intricacies of investment management is needed, which people may not always have.
• The retirement bucket strategy depends greatly on how much money a person might need after retiring. If the investor cannot correctly predict the amount, it might prove problematic. This is because when someone makes incorrect predictions, he or she might end up putting too much or too little money in one particular bucket than required.

Final Word

A solid financial plan for retirement helps a person live his life stress-free. The retirement bucket strategy helps people effectively manage their retirement corpus. 

It is a 3-bucket strategy that segregates your funds according to short-term, mid-term and long-term financial needs. Although its management can be a bit inconvenient, it offers the benefit of portfolio diversification, growth and steady income.

Frequently Asked Questions