You’ve probably never heard of liability-driven investing – or the “bucket strategy”…
But importantly, it was the strategy I used over my 25 years working for some of Wall Street’s biggest names. And it’s not only for the big money… You can do it, too!
In fact, I believe the bucket strategy is the best way for you to approach retirement. It’s a fundamental approach. And it’s easier than you might think to execute…
The trick isn’t some special set of asset classes. In reality, a diverse portfolio is the goal. And remember, you’re using it to build a steady income stream for the long haul.
But to make liability-driven investing (“LDI”) work, it’s critical to use buckets.
With that in mind, let’s learn how you can bring the LDI institutional mindset to your retirement account…
To start, build several buckets earmarked for five-to-10-year segments.
The goal of each bucket is to fund your income needs over a certain period in retirement. So if the first bucket is designed to last for 10 years, try not to dip into the second bucket until after that.
The risk exposure for each bucket depends on the amount of time until you’ll use them in your retirement plan… The longer time until you’ll need them, the more risk you can take.
That’s the basic approach to the bucket strategy. Now, here’s how you could set up a series of buckets for retirement today…
Bucket 1: Years 1 to 10
The first bucket is the foundation of the portfolio. Its sole purpose is to crank out monthly income for the first 10 years or so. As a result, you want to make sure that the assets in this bucket are well-suited to do that…
The assets in the first bucket are safe, predictable, and not subject to loss.
Social Security and pensions are a great start for this bucket. Beyond that, with interest rates so low and because most bonds are callable these days, this is one of the few instances when a single-premium immediate annuity actually makes sense…
This guaranteed, predictable income protects you from catastrophe if the markets act the way they did in March 2020. Thanks to this bucket, you won’t need to bail out of your longer-term investments… You’ve covered the “loss of income” fear in this first bucket.
That creates a mental edge… You aren’t concerned about market fluctuations in the near term.
Once you’ve taken care of that, you can focus on the longer-dated buckets. With the rest of your buckets, the point is growth…
Bucket 2: Years 11 to 15
Remember, as the length of time before you’ll need a particular bucket increases, so can the level of risk… But the potential return should be greater than your first bucket, too.
Your second bucket should still carry a relatively low amount of risk. However, it should have growth potential…
For this bucket, look across many asset classes. Stable, dividend-focused exchange-traded funds (“ETFs”) and other broad-market strategies – like thematic growth and income ETFs – are great choices.
The key to this bucket is to be balanced between growth and dividends.
Bucket 3: Years 16 to 20
This third bucket should lean toward the growth side of investing.
Time is on your side in this bucket… And compounding returns for longer periods can add up to bigger gains.
Bucket 4: Years 21 and Beyond
This bucket is designed for a more aggressive allocation. Most likely, you’ll hold a diverse set of stocks in it…
Over time, stocks have proven to be the best way to grow your wealth. The compounding effect in this bucket provides a big opportunity for growth… And since you won’t be touching this bucket for at least two decades after you retire, it’s OK to take some risks.
In my experience, folks should take one critical step with their third and fourth buckets. When a year delivers large gains, use that as an opportunity to adjust your allocations. Use the extra cash from your third and fourth buckets to replenish or extend your less-risky first and second buckets.
Think of it this way… Your longer-term buckets have overflowed, so you’re reallocating the excess reserves to your current investment accounts.
Folks, I deployed this bucket strategy when working with countless newly retired or soon-to-be-retired investors.
Simply put, your retirement account needs buckets. You can’t just throw everything into one big pool and hope for the best… You should approach these critical years with a plan.
We’ve covered the broad strokes of the bucket strategy today. But in order to put it to work, you must find out what works best for your life situation and specific goals.
No matter how your buckets are put together, having them earmarked for future years will help you stick to the plan.
Good investing,
Pete Carmasino
