Using “buckets” or multiple portfolios isn’t a new idea. I’ve seen it used for various purposes. The premise is pretty simple but proper use can be very powerful and financially rewarding. Rather than creating one portfolio that is set to mature when you reach a certain age, let’s say 65, create multiple portfolios with different target or maturation dates.
Let me explain using my wife and I as an example. Normally, a couple spends all of their working years putting money away into 401Ks and IRAs with the goal of retiring at age 65. Due to tax laws, we can’t touch the money in those retirement accounts until we reach at least age 59 1/2. So we dutifully invest money for 40 years. As youngsters, we invest aggressively because our time horizon is long and we can afford to have years with losses. But as our retirement date approaches, we move more and more money into safer investments. So our portfolio makes less money as we get closer to retirement. And yet, with the high life expectancies of today, this one portfolio will have to be sufficient enough to last us 20-30 years. But if we are only earning 3-4% each year, then we may run into trouble.
Now let’s consider using multiple buckets or portfolios. We’ll start with just a simple two bucket or portfolio approach. In this example, I expect to live 30 years after I retire at age 65.
- Portfolio 1 contains only one half of all our retirement money and is designed to be available the day we retire at age 65. So again, we slowly move money into safer investments as that day draws near. BUT, we only want this portfolio to last 15 years and then run out.
- Portfolio 2 contains the other half of our retirement money and is designed to be available when I’m 80 years old and the first portfolio runs out. Since I have an extra 15 years to invest this portfolio, I can be aggressive for much longer and earn more money before having to move to safer investments such as bonds.
So the benefit is that through using multiple portfolios, I can be more aggressive where possible and increase my potential return. Now, let’s get a bit more fancy again using my wife and I as an example.
- Portfolio 1 uses only normal, taxable accounts because I want to retire at age 50. So I need to withdraw from accounts where I don’t face tax penalties for early withdrawals. But I only need this account to last 10 years because then I can access my tax deferred (401Ks) or tax advantaged (Roth IRA) accounts.
- Portfolio 2 uses tax deferred or tax advantaged accounts and is designed to mature or be ready to use when I turn 60 and Portfolio 1 dries up. In our case, I want that account to last until we are 70.
- Portfolio 3 may use a combination of taxable and tax deferred accounts because I intend to draw every penny out of it in my 60th year in order to build our retirement home (we plan to do a lot of traveling in our 50s).
- Portfolio 4 is invested more aggressively for longer than any other account because I don’t need it until I’m 70. But then I intend to use this account until the day I die. So it has to last for 20 years.
This may seem a bit absurd or overboard, but so does coupon-ing until you try it and see the cost savings. The goal is to maximize the time that you have and the return that you can earn on your money. Don’t just make your money work for you, make it work smarter for you.
Understand, though, that this bucket approach is a numbers game. Meaning, you have to crunch a lot of numbers to determine how much money needs to be in each account on the day it is supposed to mature or be ready for use, how much money you need to put into each portfolio on a monthly or annual basis, and how much you need to be earning on average in each portfolio in order to meet your goals. So if you are not comfortable running the numbers yourself, please consult a competent financial advisor. I’m a strong advocate of hiring a professional if you need the help.
For a few ideas on selecting an advisor, you can read our post titled 5 Tips for finding a good Financial Planner.
Hopefully I’ve adequately explained the bucket approach well enough that you have at least an idea or inkling of its potential. Please feel free to ask any questions or provide suggestions to others in the comments section below.
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