The two-bucket investment approach to making money last

By Alan Ebright

Preparing for retirement is a key milestone in one’s financial journey, requiring thoughtful planning, strategic investing and effective asset allocation. After working for decades, the goal is to build sufficient savings to sustain a comfortable retirement that could last 25 years or longer. A well-structured financial strategy ensures long-term stability and peace of mind.

Understanding the two-bucket investment approach

The two-bucket investment approach is a well-balanced strategy designed to provide both stability and growth. Each bucket serves a distinct purpose in preserving financial security while enabling long-term asset appreciation.

Bucket #1: Stability and liquidity

The first bucket is intended to cover near-term expenses during retirement. It comprises stable, liquid assets such as money-market funds and short-term bonds. The primary function of this bucket is to ensure immediate access to funds for daily living expenses, reducing exposure to market fluctuations.

Bucket #2: Growth and long-term investing

The second bucket focuses on capital appreciation through stocks and other growth-oriented investments. These assets have historically provided higher returns over extended periods compared to cash or bonds. This bucket aims to protect against inflation and sustain financial security throughout retirement.

Striking a balance between risk and return

A common question arises: Why not keep all savings in a bank account or money-market fund to avoid market volatility? Although such options offer short-term security, they often fail to outpace inflation, diminishing purchasing power over time. Incorporating growth investments is essential to maintaining long-term financial health.

Determining the right allocation

Success with the two-bucket investment approach depends on properly balancing assets between the two buckets. A commonly recommended guideline is to keep at least five years' worth of expenses in Bucket #1. This cushion minimizes the need to sell stocks from Bucket #2 during market downturns, ensuring a more resilient investment strategy. Shortening this timeframe to three or four years increases the risk of having to sell stocks before they recover from market volatility.

Creating a sustainable retirement plan using the two-bucket approac

To develop a lasting financial plan, it’s important to evaluate key variables:

Initial withdrawal rate. The percentage of total savings withdrawn in the first year of retirement. For example, with $2 million in savings and an annual withdrawal of $100,000, the rate would be 5%.
Years of spending in Bucket #1. Establishing how long this bucket will sustain expenses before replenishment is needed.
Assumed inflation rate. Estimating annual increases in living costs throughout retirement.
Expected after-tax returns. Projecting performance based on anticipated returns from both stocks and fixed-income assets.

By incorporating these factors into retirement planning, investors can estimate how long their savings will last and adjust their strategy accordingly.

Maintaining a long-term perspective

Legendary investor Warren Buffett once said, "Rule #1 is never lose money. Rule #2 is never forget Rule #1." While stocks have historically delivered superior returns over time, short-term fluctuations are inevitable. The two-bucket investment approach helps retirees maintain a disciplined perspective, securing essential living expenses in Bucket #1 while allowing investments in Bucket #2 to grow.

Planning for retirement requires a well-structured financial approach to ensure long-term stability. The two-bucket investment approach provides a balanced strategy, allowing retirees to manage risk while capitalizing on growth opportunities. By carefully allocating assets and making informed financial decisions, individuals can create a retirement plan tailored to their needs, ensuring financial security and peace of mind for the years ahead. Thoughtful planning today paves the way for a confident and fulfilling retirement journey.