How to use the retirement bucket strategy to protect your nest egg

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Spread things out to guard against a downturn.

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Q: How much money do you need to retire?

A: As much as possible.

That means maximizing the return on your investment dollars throughout your working years. But it also means protecting that nest egg as you enter and live through your retirement years.

One of the biggest concerns among retirement savers is how to navigate a down market, particularly if you need to sell assets to cover living costs. Consider the retirement bucket strategy to help you minimize risk in the short term but target larger gains in the long term.

The idea behind the three-bucket strategy is simple: You keep your money in three different buckets based on when you think you’ll need it.

First, understand your financial needs and goals. Then you can plan how much money to keep in each bucket and make adjustments as needed.

Market downturns are a fact of life. In fact, if you enjoy a long retirement that lasts some decades, there’s a good chance you’ll see a few down cycles during that time. But market downturns that happen toward the end of your working years and/or early in your retirement can have an outsize impact on your ability to outlive your money. If you have to sell assets early on during a market crash, that can deplete your portfolio.

This is known as sequence-of-return risk. For example, according to the Schwab Center for Retirement Research, someone with a $1 million nest egg who takes an initial withdrawal of $50,000 and then increases withdrawals 2% annually could run out of money in less than 20 years if they experience negative 15% returns during the first two years of retirement. On the other hand, a similar retiree who didn’t see those negative returns until later in retirement is likely to outlive their money.

The retirement bucket strategy can help protect your nest egg by providing a reserve to get you through a downturn. For example, if you plan to retire in the next two years, and the market has been on an extended bull run, it might be a good time to rebalance your portfolio and take some profits (and risk) off the table.

Consider adding a chunk of money to your short-term bucket, and perhaps transfer a portion to your medium bucket. If the economy turns sour and the market corrects itself lower during that first year or two of your retirement, you won’t have to sell at a bargain-basement price in order to pay your month-to-month expenses.

Meanwhile, the assets in your medium-term bucket will hopefully continue to provide income via bond interest and stock dividends. You can use those proceeds to supplement your income, or you can use them to buy lower-cost assets during the downturn and add them to your long-term bucket. The assets in the long-term bucket are likely to recover over time—not a guarantee, but they always have in the past, eventually. And because you weren’t forced to sell shares during the downturn, your portfolio should benefit from the subsequent recovery.

The three-bucket strategy for retirement isn’t just for your later years. This strategy can also be used to target your pre-retirement savings goals. Here’s how:

At some point, you’ll need to transfer assets from one bucket to another, especially if you use the bucket investing strategy during retirement. You’ll probably deplete your short-term bucket regularly if that’s the pool of money you use for everyday expenses.

Here are some tips for transferring assets:

There’s no predicting the future. Retiring into a downturn can significantly deplete your nest egg if you don’t have a contingency plan to reduce the likelihood you’ll need to sell assets during a down period.

With the help of the retirement bucket strategy, you can (at least partially) protect your nest egg by creating a reserve to draw on while markets are down.