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Bucket strategies for retirement cash flow

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Enter the words “retirement,” “portfolio,” and “bucket” into Google and you get about 463,000 results. Apparently, while a bucket list might be fine for final activities, a bucket approach is a popular way to draw retirement income from an investment portfolio.

If there’s a common denominator to this bucket brigade, it’s the use of a sizable cash bucket. “We like to see retired clients with at least a year’s worth of needed funds in cash equivalents such as money market funds,” says Eric Meermann, client service manager with Palisades Hudson Financial Group in Scarsdale, N.Y.

Thus, a client who needs, say, $5,000 a month from his or her portfolio would hold at least $60,000 in cash. That money is ready to spend, replacing the now-forgone paychecks, so a retiree’s lifestyle won’t be immediately affected by market volatility.

Often, this mode of retirement planning groups a client’s other assets into fixed income and equity buckets. As the cash bucket is depleted, it might be replenished from the fixed income bucket, which in turn will be refilled from the equities bucket.

REFILLING THE CASH BUCKET

Other tactics could include using bond redemptions, interest income, stock dividends, or proceeds from capital losses to keep the cash bucket topped up. In any case, a bucket strategy for drawing down retirees’ investment assets needs a plan for refilling the cash bucket.

“In the drawdown phase, we use a client’s asset allocation to determine how to move money into cash,” says Meerman. “If a client’s target allocation is 50% in equities and 50% in bonds and cash, for example, we’d move money from both sides into cash, to maintain that allocation.”

At times, Meerman adds, asset allocations go far out of line, perhaps due to market volatility. “In 2008-2009,” he says, “when stocks fell sharply, our allocations became tilted towards fixed income. At that point, we wouldn’t use money from equities to restore a retiree’s cash position.” Instead, the firm rebalanced clients’ allocations, moving money from fixed income into equities, and retirees’ cash positions were refilled from fixed income rather than from equities.

“The reverse is true when our equity allocations exceed our fixed income targets,” says Meerman. Recently, as the bull market has elevated clients’ allocations to stocks, his firm has been moving money from equities into retirees’ cash holdings. “The domestic stock market has been outperforming international markets,” he notes, “so we’ve been taking more from U.S. equities.”

SEQUENCE OF RETURNS

Typically, reports Meerman, clients’ asset allocations don’t vary as they go through retirement. “We use a client’s needs and risk tolerance to set the allocations,” he says, “and those usually won’t change unless a major life event occurs. However, we do have some flexibility with these plans. If there’s a significant decline in a client’s wealth, perhaps in a bear market, we might suggest spending less, which would mean taking less from the portfolio.”

Such a pullback could ameliorate the so-called “sequence of returns” effect, which refers to the impact of a bear market in the early years of retirement.

However, Meerman declines to suggest the opposite approach—increasing spending if a bull market bolsters a client’s wealth. “That’s too close to market timing,” he asserts. “The key reason to plan for drawing down a portfolio is to provide discipline over what might be a long retirement.”

Donald Jay Korn is a Financial Planning contributing writer in New York. He also writes regularly for On Wall Street.

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