Creating Retirement Income with Buckets of money
Written by Jim Yih •
Interest rates have played a big role in changing the retirement landscape. I’ve always said, the best time to retire was back in 1981 when interest rates were at the peak. If you retired back then, you could take all of the money you saved and plunk it into a good old-fashioned GIC and earn 12% to 21%. If you think about it, most retirees could easily live off the interest and keep their capital 100% secured. Unfortunately, those good old days are long gone.
Since 1981, we have seen a massive decline in interest rates and today retirees can get 1%, 2% or 3% if they really shop around. It’s tough now for the retiree to live on less than 3% interest in a safe environment. So instead of low returns in a safe environment, most investors have moved money to riskier places in a quest to do better. If you think about it, this has created a new set of problems for the retiree or the soon-to-be-retiree.
How many of you know people who delayed their retirement because of the stock market and what a correction did to their portfolio? How many of you know people who retired but then had to go back to work because a stock market correction caused them to lose too much money?
Variable returns can work against you
One of the problems of return projections in the financial industry is that most of the math is modeled on a straight line. For example, the math on a 7% average return really assumes that you make 7% per year each and every year.
The real problem is most portfolios don’t move in a straight line anymore. Instead the move up and down with peaks and valleys. What if you did the math of withdrawing income on and investments that fluctuates with variable returns as opposed to an investment that moved in the path of a straight line? Would the results be different?
Avoiding the risk of bad timing.
One of the new risks that retirees face is the risk of bad timing. What happens if you retire just as the market is correcting? What happens if you retire and then the market corrects shortly thereafter? Some have coined this the retirement risk zone.
To prevent yourself from changing your timing of retirement because of something you can’t control or predict, you can use the bucket strategy to creating retirement income.
What is the Bucket strategy to retirement income?
Basically what you do is set up your investments in hypothetical buckets like in the diagram. In one bucket you fill it with investments that are safe so that you can pay your self the necessary income you need from your portfolio for at least 5 years. Then you fill another bucket with investments that might be a little riskier but with a time frame of 5 to 10 years in mind. This might include some fixed income investments or even some income paying investments like REITS or Blue Chip Dividend paying investments.. The last bucket might contain some riskier investments to help combat inflation over the long run.
When the short-term bucket drains down because of income to the retiree, then you can fill it up with the next bucket. And then the 5 to 10 year bucket drains down, you can fill it up with the last bucket. In theory, the older you get, the more conservative your portfolio becomes.
The main idea of the bucket strategy is that short-term volatility in the markets does not affect your ability to create income in the short term. The bucket strategy can take away some of the stress of market swings.