Thoughts on the three bucket strategy.

[theObserver]

(Background: https://www.askaboutmoney.com/threads/thought-experiment-55-retired-and-managing-assets.236124/)

I want to type out my thoughts on the three bucket withdrawal strategy to help think it through and to give people an opportunity to correct me.

The bucket strategy was created by legendary financial planner Harold Evensky to solve the problem of retirees panic selling during market downturns.

The original strategy was just two buckets and simply increased the amount of cash holding to 2-5 years and refilling each quarter by re-balancing (selling stocks when the market is up to buy bonds or selling bonds to buy shares with market is down).

Eventually people went from 2-5 years of cash holdings down to 1-2 years better balance returns and peace-of-mind-cash.





If two buckets are good, then three must be better, right? So over time people started adding additional buckets to the plan.

It’s important realize there is a huge difference between the two and the three (or more) buckets strategy. The two buckets strategy simply increased the cash holdings while the various three or more buckets strategy moved away from percentages (60% shares , 40% bonds etc) towards years and the allocation of certain asset types into each bucket:



Let’s ask again: what problem is this intended to solve?

Well, the cynic in me thinks the primary goal is for financial advisers to sell an overly complex retirement plan.

But, ignoring the cynic, I notice the additional bucket can provide additional peace of mind while offering some growth. The switch from percentages to years also helps reassure: “I know I am funded for the next five to ten years whatever happens.” etc

At this point we should bring in the Mental Accounting bias which I believe is important to understanding the appeal of the three bucket strategy:

"Mental accounting is our tendency to mentally sort our funds into separate “accounts,” which affects the way we think about our spending. Mental accounting leads us to see money as less fungible than it is and makes us susceptible to biases such as the sunk cost fallacy.
The two bucket strategy involves taking money out the market for instantly available cash; in effect sacrificing returns for peace of mind. "

The three plus buckets strategy plays off the Mental Accounting bias by encouraging us to create additional categories of funds for additional peace of mind.

Returning to the original question, what problem does the three bucket strategy solve as those with lower risk tolerance should hold more cash either in a current/saving account or/and hold more bonds?

The introduction of a third or more buckets, and switching from percentages to years, does superfluously offer peace of mind but its hard to see the real advantages over the original two bucket system created by Harold Evensky. Perhaps the mental accounting image of buckets filling with money and flowing periodically into a current account resembles a pay cheque or a pipeline but this is mostly smoke and mirrors.

I do however see a use for three buckets in determining your risk tolerance:

What is the minimum amount of cash do you need to feel secure during market downturns and economic trouble? (this is bucket 1)
How much cash beyond bucket 1 do you need to have peace of mind ? (Bucket 2 split 50/50 bonds and equities).
Everything else in bucket 3 (stocks).

But this is really just deciding on the initial allocation of cash/bonds/stocks with yearly or quarterly re-balancing afterwards,

I was initially very excited by the Three Bucket strategy, believing it offered a reliable pipeline of money flowing from the market into my account each year. Having dug into it more however I have come to believe it merely offers an illusion of peace of mind at the cost of lower returns from investments.

Conclusion: Keep it simple. A two buckets conceptual strategy is enough.

 

[Deauville]

(Background: https://www.askaboutmoney.com/threads/thought-experiment-55-retired-and-managing-assets.236124/)

I want to type out my thoughts on the three bucket withdrawal strategy to help think it through and to give people an opportunity to correct me.

The bucket strategy was created by legendary financial planner Harold Evensky to solve the problem of retirees panic selling during market downturns.

The original strategy was just two buckets and simply increased the amount of cash holding to 2-5 years and refilling each quarter by re-balancing (selling stocks when the market is up to buy bonds or selling bonds to buy shares with market is down).

Eventually people went from 2-5 years of cash holdings down to 1-2 years better balance returns and peace-of-mind-cash.

View attachment 8966

View attachment 8967

If two buckets are good, then three must be better, right? So over time people started adding additional buckets to the plan.

It’s important realize there is a huge difference between the two and the three (or more) buckets strategy. The two buckets strategy simply increased the cash holdings while the various three or more buckets strategy moved away from percentages (60% shares , 40% bonds etc) towards years and the allocation of certain asset types into each bucket:

View attachment 8968

Let’s ask again: what problem is this intended to solve?

Well, the cynic in me thinks the primary goal is for financial advisers to sell an overly complex retirement plan.

But, ignoring the cynic, I notice the additional bucket can provide additional peace of mind while offering some growth. The switch from percentages to years also helps reassure: “I know I am funded for the next five to ten years whatever happens.” etc

At this point we should bring in the Mental Accounting bias which I believe is important to understanding the appeal of the three bucket strategy:


The three plus buckets strategy plays off the Mental Accounting bias by encouraging us to create additional categories of funds for additional peace of mind.

Returning to the original question, what problem does the three bucket strategy solve as those with lower risk tolerance should hold more cash either in a current/saving account or/and hold more bonds?

The introduction of a third or more buckets, and switching from percentages to years, does superfluously offer peace of mind but its hard to see the real advantages over the original two bucket system created by Harold Evensky. Perhaps the mental accounting image of buckets filling with money and flowing periodically into a current account resembles a pay cheque or a pipeline but this is mostly smoke and mirrors.

I do however see a use for three buckets in determining your risk tolerance:

What is the minimum amount of cash do you need to feel secure during market downturns and economic trouble? (this is bucket 1)
How much cash beyond bucket 1 do you need to have peace of mind ? (Bucket 2 split 50/50 bonds and equities).
Everything else in bucket 3 (stocks).

But this is really just deciding on the initial allocation of cash/bonds/stocks with yearly or quarterly re-balancing afterwards,

I was initially very excited by the Three Bucket strategy, believing it offered a reliable pipeline of money flowing from the market into my account each year. Having dug into it more however I have come to believe it merely offers an illusion of peace of mind at the cost of lower returns from investments.

Conclusion: Keep it simple. A two buckets conceptual strategy is enough.

Thanks for your thoughts.

I came across an evidence based paper some time ago which concluded that a bucket strategy had the benefit of a psychological crutch and helps some sleep better during volatility. At the expense of having funds out of the market thus missing out on potential growth.
If I can find the paper I’ll post a link.

My preference for an ARF is for a two bucket strategy.
Bucket 1. Three year money market fund equivalent to three year deemed distribution. This would be to help mitigate a problematic sequence of return in first few years and allow for restful sleep.
I would only use this bucket if needed and wouldn’t top it up.
Bucket 2. Remainder in 60/40 ish ESMA risk rating 5 ish portfolio. Which i would rebalance twice yearly manually for first few years and subsequently automatically rebalance six monthly when bucket one is gone.
Distribution in December each year.

I’m aiming for an ARF that will as far as possible operate automatically as I get older and start to dribble……….more.

 

[theObserver]

Thanks for your thoughts.

I came across an evidence based paper some time ago which concluded that a bucket strategy had the benefit of a psychological crutch and helps some sleep better during volatility. At the expense of having funds out of the market thus missing out on potential growth.
If I can find the paper I’ll post a link.

My preference for an ARF is for a two bucket strategy.
Bucket 1. Three year money market fund equivalent to three year deemed distribution. This would be to help mitigate a problematic sequence of return in first few years and allow for restful sleep.
I would only use this bucket if needed and wouldn’t top it up.
Bucket 2. Remainder in 60/40 ish ESMA risk rating 5 ish portfolio. Which i would rebalance twice yearly manually for first few years and subsequently automatically rebalance six monthly when bucket one is gone.
Distribution in December each year.

I’m aiming for an ARF that will as far as possible operate automatically as I get older and start to dribble……….more.

I need to learn more about ARFs but if you plan on manually rebalancing why not manage your own investments directly? When the dribbling becomes too annoying, you could take out an annuity (I think).

 

[Deauville]

Manually in this case as I want to maintain numerical value of Bucket 1 minus whatever I’ve taken out.
Say 30k in a year where asset values in bucket 2 were down due to market volatility I could draw from bucket 1 rather than Bucket 2 or overall portfolio percentage.
This avoids cashing out units of assets when they’re down.
‘Sequence of return risk’ is worth checking out.
It can have a serious impact on a portfolio outcome.
I don’t intend to maintain a bucket strategy for long. Just for first few lucid years.
Then set auto pilot and try to keep my hands in my pockets.

By setting auto rebalance, I would also rebalance Bucket 1.
I wouldn’t want that initially.
I only want to rebalance the other funds.

As for self directing an ARF, too much work for me personally. As I dribble more, it would be even more challenging.

I’ve been studying Zurich funds and intend building a portfolio of funds that meet my needs.
Zurich have great tools to help.
I then intend to use an execution only broker to reduce costs.

Self directed is an entirely different approach and isn’t what’s commonly called execution only.
In execution only, you tell the intermediary what product you want and from which provider. No advice sought or can be given.

Some intermediaries offer advice based or execution only.

I hope that’s not complete gobleygook

 

[Flybytheseat]

I’ve been studying Zurich funds and intend building a portfolio of funds that meet my needs.
Zurich have great tools to help.
I then intend to use an execution only broker to reduce costs.

Im curious as to whether you intend to use actively managed Zurich funds such as Prisma 5 or their passive global equity fund such as the indexed gloabl equity (Blackrock) ? Will a Zurich ARF allow you to determine whether deemed distribution comes from the money market fund or the Bucket 2 portfolio ?

 

[Deauville]

Im curious as to whether you intend to use actively managed Zurich funds such as Prisma 5 or their passive global equity fund such as the indexed gloabl equity (Blackrock) ? Will a Zurich ARF allow you to determine whether deemed distribution comes from the money market fund or the Bucket 2 portfolio ?

I intend to use a mix of funds but only one (Prisma 2) will be actively managed. It’s a small percentage but I’m including it to compliment the mix of assets I’m aiming for.
The rest all have very low fund and other ongoing charges.
I’ll happily share my preference but I don’t have it to hand at the moment.
Yes, Zurich allow us to choose which fund to draw from.
The default though is for it to be a percentage of portfolio.
They have recently also facilitated auto rebalancing of funds within portfolio.

I don’t work in financial services. I’m not trying to sell Zurich. I’m just drawn to their offerings and performance.

 

[Deauville]

Im curious as to whether you intend to use actively managed Zurich funds such as Prisma 5 or their passive global equity fund such as the indexed gloabl equity (Blackrock) ? Will a Zurich ARF allow you to determine whether deemed distribution comes from the money market fund or the Bucket 2 portfolio ?

Here’s my Draft potential portfolio.
I will have to tweak percentages to accommodate Bucket 1. Numerical distribution of a reserve 3 years.
For example 3 x 30k. So whatever percentage of the overall portfolio the remainder allocated to the non cash funds (Bucket 2)
As I mentioned, I don’t intend to top up the cash fund.
My aim is that the portfolio will become auto rebalanced in time.
I want to keep it low charge and simple.

ESMA 5. Portfolio Volatility 10.79 Created March 2024.

40% Indexed Global Equity Fund.
15% Prisma 2.
15% International Equity.
10% Cash.
10% Active Fixed Income.
10% Dividend Growth.

Assets at March 2024

65.65% Equities
20.45% Bonds
13.00% Cash

Again, I”m not an expert and don’t work in financial services.

Open to suggestions.

 

[Redzer]

Another factor to consider is the effect on Bucket 1 of any incoming cashflow from:

1. the 4% deemed distribution from an ARF starting from the year you turn 61 (5% from 71)
2. Contributory State Pension / 065 Benefit
3. Any other source (e.g. Inheritance).

These will "automatically" top up the cash fund.

I'm also planning a bucket strategy primarily to mitigate Sequence of Returns risk. Whether you call it a 2 or 3 bucket strategy I'm going for something with 3 elements - Cash (2-3 years expenses) , a Stable growth fund (including bonds for another 2-3 years expenses) & a passive Global Equity Index fund for the rest. I can remember 2008-2013 and I'd rather sleep easy and spend happily using the above version. I'd only plan on re-balancing when the Global Equity Index fund is positive where possible.

 

[Fortune]

Here’s my Draft potential portfolio.
I will have to tweak percentages to accommodate Bucket 1. Numerical distribution of a reserve 3 years.
For example 3 x 30k. So whatever percentage of the overall portfolio the remainder allocated to the non cash funds (Bucket 2)
As I mentioned, I don’t intend to top up the cash fund.
My aim is that the portfolio will become auto rebalanced in time.
I want to keep it low charge and simple.

ESMA 5. Portfolio Volatility 10.79 Created March 2024.

40% Indexed Global Equity Fund.
15% Prisma 2.
15% International Equity.
10% Cash.
10% Active Fixed Income.
10% Dividend Growth.

Assets at March 2024

65.65% Equities
20.45% Bonds
13.00% Cash

Again, I”m not an expert and don’t work in financial services.

Open to suggestions.

How does the dividend growth operate? Does it distribute the dividends to you somehow?

 

[Deauville]

How does the dividend growth operate? Does it distribute the dividends to you somehow?

No, it’s within the fund. Dividends are reflected in the fund unit price as they would be reinvested within the fund.
Looking at performance of dividend growth funds, they appear to perform better than the international equity fund or similar in a downturn. Dividends would still be coming in.

I view a bucket strategy, dividends, bonds, cash as an insurance premium for a little peace of mind.
The premium is the potential reduction in return.
Horses for courses I suppose.

 

[Deauville]

(Background: https://www.askaboutmoney.com/threads/thought-experiment-55-retired-and-managing-assets.236124/)

I want to type out my thoughts on the three bucket withdrawal strategy to help think it through and to give people an opportunity to correct me.

The bucket strategy was created by legendary financial planner Harold Evensky to solve the problem of retirees panic selling during market downturns.

The original strategy was just two buckets and simply increased the amount of cash holding to 2-5 years and refilling each quarter by re-balancing (selling stocks when the market is up to buy bonds or selling bonds to buy shares with market is down).

Eventually people went from 2-5 years of cash holdings down to 1-2 years better balance returns and peace-of-mind-cash.

View attachment 8966

View attachment 8967

If two buckets are good, then three must be better, right? So over time people started adding additional buckets to the plan.

It’s important realize there is a huge difference between the two and the three (or more) buckets strategy. The two buckets strategy simply increased the cash holdings while the various three or more buckets strategy moved away from percentages (60% shares , 40% bonds etc) towards years and the allocation of certain asset types into each bucket:

View attachment 8968

Let’s ask again: what problem is this intended to solve?

Well, the cynic in me thinks the primary goal is for financial advisers to sell an overly complex retirement plan.

But, ignoring the cynic, I notice the additional bucket can provide additional peace of mind while offering some growth. The switch from percentages to years also helps reassure: “I know I am funded for the next five to ten years whatever happens.” etc

At this point we should bring in the Mental Accounting bias which I believe is important to understanding the appeal of the three bucket strategy:


The three plus buckets strategy plays off the Mental Accounting bias by encouraging us to create additional categories of funds for additional peace of mind.

Returning to the original question, what problem does the three bucket strategy solve as those with lower risk tolerance should hold more cash either in a current/saving account or/and hold more bonds?

The introduction of a third or more buckets, and switching from percentages to years, does superfluously offer peace of mind but its hard to see the real advantages over the original two bucket system created by Harold Evensky. Perhaps the mental accounting image of buckets filling with money and flowing periodically into a current account resembles a pay cheque or a pipeline but this is mostly smoke and mirrors.

I do however see a use for three buckets in determining your risk tolerance:

What is the minimum amount of cash do you need to feel secure during market downturns and economic trouble? (this is bucket 1)
How much cash beyond bucket 1 do you need to have peace of mind ? (Bucket 2 split 50/50 bonds and equities).
Everything else in bucket 3 (stocks).

But this is really just deciding on the initial allocation of cash/bonds/stocks with yearly or quarterly re-balancing afterwards,

I was initially very excited by the Three Bucket strategy, believing it offered a reliable pipeline of money flowing from the market into my account each year. Having dug into it more however I have come to believe it merely offers an illusion of peace of mind at the cost of lower returns from investments.

Conclusion: Keep it simple. A two buckets conceptual strategy is

(Background: https://www.askaboutmoney.com/threads/thought-experiment-55-retired-and-managing-assets.236124/)

I want to type out my thoughts on the three bucket withdrawal strategy to help think it through and to give people an opportunity to correct me.

The bucket strategy was created by legendary financial planner Harold Evensky to solve the problem of retirees panic selling during market downturns.

The original strategy was just two buckets and simply increased the amount of cash holding to 2-5 years and refilling each quarter by re-balancing (selling stocks when the market is up to buy bonds or selling bonds to buy shares with market is down).

Eventually people went from 2-5 years of cash holdings down to 1-2 years better balance returns and peace-of-mind-cash.

View attachment 8966

View attachment 8967

If two buckets are good, then three must be better, right? So over time people started adding additional buckets to the plan.

It’s important realize there is a huge difference between the two and the three (or more) buckets strategy. The two buckets strategy simply increased the cash holdings while the various three or more buckets strategy moved away from percentages (60% shares , 40% bonds etc) towards years and the allocation of certain asset types into each bucket:

View attachment 8968

Let’s ask again: what problem is this intended to solve?

Well, the cynic in me thinks the primary goal is for financial advisers to sell an overly complex retirement plan.

But, ignoring the cynic, I notice the additional bucket can provide additional peace of mind while offering some growth. The switch from percentages to years also helps reassure: “I know I am funded for the next five to ten years whatever happens.” etc

At this point we should bring in the Mental Accounting bias which I believe is important to understanding the appeal of the three bucket strategy:


The three plus buckets strategy plays off the Mental Accounting bias by encouraging us to create additional categories of funds for additional peace of mind.

Returning to the original question, what problem does the three bucket strategy solve as those with lower risk tolerance should hold more cash either in a current/saving account or/and hold more bonds?

The introduction of a third or more buckets, and switching from percentages to years, does superfluously offer peace of mind but its hard to see the real advantages over the original two bucket system created by Harold Evensky. Perhaps the mental accounting image of buckets filling with money and flowing periodically into a current account resembles a pay cheque or a pipeline but this is mostly smoke and mirrors.

I do however see a use for three buckets in determining your risk tolerance:

What is the minimum amount of cash do you need to feel secure during market downturns and economic trouble? (this is bucket 1)
How much cash beyond bucket 1 do you need to have peace of mind ? (Bucket 2 split 50/50 bonds and equities).
Everything else in bucket 3 (stocks).

But this is really just deciding on the initial allocation of cash/bonds/stocks with yearly or quarterly re-balancing afterwards,

I was initially very excited by the Three Bucket strategy, believing it offered a reliable pipeline of money flowing from the market into my account each year. Having dug into it more however I have come to believe it merely offers an illusion of peace of mind at the cost of lower returns from investments.

Conclusion: Keep it simple. A two buckets conceptual strategy is enough.

Here’s the title of the paper I referred to. A search on google should bring it up.

The Bucket Approach for Retirement: A Suboptimal Behavioral Trick?

 

[Fortune]

No, it’s within the fund. Dividends are reflected in the fund unit price as they would be reinvested within the fund.
Looking at performance of dividend growth funds, they appear to perform better than the international equity fund or similar in a downturn. Dividends would still be coming in.

I view a bucket strategy, dividends, bonds, cash as an insurance premium for a little peace of mind.
The premium is the potential reduction in return.
Horses for courses I suppose.

I don't really see the point of that. You don't see the benefit of the dividends.

 

[theObserver]

I don't really see the point of that. You don't see the benefit of the dividends.

It's how accumulating ETFs also work. You gain through the fund compounded price growth without paying the tax a dividend would trigger (until you sell of course).

 

[money_man]

It's how accumulating ETFs also work. You gain through the fund compounded price growth without paying the tax a dividend would trigger (until you sell of course).

But why move the balance towards high dividend paying stock if you're not taking a dividend? Just put that bucket into the passive index fund? (thats a question, I'm not saying I'm definitely right!)

 

[Deauville]

It’s as Observer said.
You are getting the dividend. Just indirectly.
The price of the units reflect the reinvested dividends.

 

[Flybytheseat]

I intend to use a mix of funds but only one (Prisma 2) will be actively managed. It’s a small percentage but I’m including it to compliment the mix of assets I’m aiming for.
The rest all have very low fund and other ongoing charges.

Just to let you know the International Equity Fund is also actively managed. Appears to have performed better than the passive managed equivalent (Indexed Global Equity Fund) though its difficult to make a full comparison without knowing the Fund Management Charge (FMC) portion of the AMC for both funds. It's a pity Zurich dont publish FMCs for their funds for full tranparency (or at least I cant find them anways) though I do agree with you on the useful tools they have on their website. I'm leaning towards a similar allocation as you suggest though I'll probably up the equity content to >70% at the expense of some of the bond funds.

 

[Deauville]

Just to let you know the International Equity Fund is also actively managed. Appears to have performed better than the passive managed equivalent (Indexed Global Equity Fund) though its difficult to make a full comparison without knowing the Fund Management Charge (FMC) portion of the AMC for both funds. It's a pity Zurich dont publish FMCs for their funds for full tranparency (or at least I cant find them anways) though I do agree with you on the useful tools they have on their website. I'm leaning towards a similar allocation as you suggest though I'll probably up the equity content to >70% at the expense of some of the bond funds.

‘Just to let you know the International Equity Fund is also actively managed’.

That’s a good point but its performance is similar to an index, it doesn’t have an additional AMC and the other ongoing charges (at Feb 2024) are only 0,04%. I note though that the Indexed Global Equity Blackrock OOC is 0.01%.


I found useful fund information through the following route.

Zurich.ie - Broker - Zurich Life Broker Centre - Funds - Fund Range - Equity - Global Equity - Indexed Global Equity Blackrock - Find Out If The Fund Is Available For Your Product.

It will bring you a list of funds, what products they’re available for, their additional AMC if any and the funds OOC’s.

Worth saving the PDF for reference.

 

[Flybytheseat]

Thanks - managed to find the Fund Manager Charge for the Prisma funds (0.4%) so presumably this is the FMC for all the funds without additional AMC called out on their list.

Given that execution only brokers charge 0.15% to .25% pa (depending on broker and ARF value) I should hopefully be able to source a Zurich ARF with AMC/TER of 0.65%-0.7% which sounds reasonable.

 

[Deauville]

Thanks - managed to find the Fund Manager Charge for the Prisma funds (0.4%) so presumably this is the FMC for all the funds without additional AMC called out on their list.

Given that execution only brokers charge 0.15% to .25% pa (depending on broker and ARF value) I should hopefully be able to source a Zurich ARF with AMC/TER of 0.65%-0.7% which sounds reasonable.

My understanding is that for example, a Prisma 5 fund in an ARF would have no additional fund AMC.
Prisma 5 has a 0.07 other ongoing charge (OOC)

So for example, if you bought an ARF using that fund alone you may have the following charges.

Provider AMC of 0.6%
OOC 0.07%
Intermediary trailing charge 0.25%.

Total 0.92% per annum.

The more active the funds are, the higher the OOC.

Hence, I try to pick funds within the portfolio with low fund OOC’s
and do homework and go execution only if feeling comfortable to do so.

It’s not all about charges of course. Diversity and performance are also important to me.

Be mindful too that charges for funds within a PRSA are different to those for the same within an ARF and are listed separately on later pages within that list.

Make sense ?
Open to correction and suggestions.

 

[Steven Barrett]

Back to the OP, it is basic planning

1. Cash account for cashflow purposes
2. Investment account for medium term expenses. This can be anything from paying for education expenses or anything other expense you may have before retirement
3. Pension for long term wealth
4. Use the investment account in point 2. for other excess cash

Some people need to segment money for different needs., like keeping money for children's education separate to the excess cash investment account. There is no need to do this but if it makes you feel more comfortable with your finances, then go for it, it's not the end of the world. Having two accounts instead of one isn't the end of the world. It's the people who have none that is the issue.

All investment accounts should be equity based primarily. This is where your growth is going to come from. Add in bonds to reduce volatility as per your tolerance.


Steven
www.bluewaterfp.ie