The bucket strategy divides your spending into three simple categories, immediate spending, medium-term goals, long term savings.

The bucket strategy divides your spending into three simple categories:   

  • Bucket 1 holds immediate spending, or money you’ll need in two years.
  • Bucket 2 contains medium-term goals or spending — for three to 10 years.
  • Bucket 3 is money you don’t plan to touch for at least 11 years.


While the bucket strategy is usually used to manage retirement spending, it can also apply to people during their working life. Bucket 1 is your emergency fund. As long as you’re working, this bucket probably doesn’t need to contain more than three to six months of spending needs, and a bit more if you own a home (for repairs) or expect significant medical expenses including deductibles and out-of-pocket costs.

Bucket 1 should be stashed in an account that’s immediately accessible — a savings account, an online savings account (currently paying higher interest), a money market or maybe a short-term bond mutual fund. This last varies in price, so it shouldn’t contain all your funds in Bucket 1 —you want easily accessed and rock solid emergency funds if you need them. Still, if six months of need is in the high five or six figures, you may want to put some in a short-term bond when savings rates are low — these funds clock in at about a 1.85-2% return.

Bucket 2 is goal savings: buying a house, taking a sabbatical, saving for college or funding an expensive hobby. I usually recommend that Bucket 1 be fully funded, then start shifting money to goal savings. I recommend at least 10% of income be devoted to filling Bucket 1.

Once Bucket 1 has a sufficient emergency fund, you prioritize Bucket 3, your retirement savings goal. Bucket 2 takes the pour over after you’ve funded Bucket 1 and begun contributions to Bucket 3. Bucket 2 is also your wealth-building bucket. The difference between having enough and building real wealth is often not only fully
funding retirement accounts to the allowable limit, but also accumulating money.

Analyze your goals for Bucket 2 — is it something you must have by a deadline, or something you can forgo until the money is available? Can your home purchase be delayed? Can you pay college expenses out of income? Depending on your own circumstances, you may want to choose a balanced fund, or an age-based fund or swing to more the hope of quicker return: an all-stock fund.

Bucket 3 is your retirement fund. Your risk tolerance depends on your age and what allows you to sleep at night. As every target retirement fund portfolio illustrates, the assumption is that the younger you are, the more risk (stock) you can tolerate. But if you have a job that might be phased out or you plan to retire early, you may want an asset allocation that is less risky than an age-based one.


We’re still going to consider three buckets, but in retirement we’re looking to pour out from the buckets rather than keep filling them. For purposes of our discussion, let’s say the person (or couple)has a $1.25 million portfolio and plans to withdraw $50,000 each year, adjusting for inflation. This is using the safe 4% withdrawal rule of thumb. Note that more fine-tuning, or investing in an annuity or long-term care insurance, may change the safe withdrawal rate, but you’re going to need some financial advice to calculate it.

Bucket 1 still holds cash and short-term securities, but in retirement this is a bigger bucket. Keep enough in cash and short-term funds to cover two years of withdrawals from your portfolio. Don’t get confused — this isn’t two years’ total income or planned spending. Some income comes from Social Security and any annuity or pension benefits. It’s what you’ve planned as a safe withdrawal that will allow your portfolio to last for the rest of your life.

Bucket 2 is the medium-distance bucket. This bucket is meant to provide moderate but dependable returns. Choose a moderately safe allocation that will still produce returns. This was an ideal spot for bonds when bonds were paying 5% or better, but now you’ll probably need some mix of bond funds (intermediate to long term) and stable dividend-paying stocks or stock funds. This is also a place to consider a balanced fund with a long-time track record, which will offer you a moderate preselected mix but would tilt the entire portfolio to a higher risk level because of the stock investments. For our investor, this bucket will probably begin with about $350,000 (about seven years of expected needs). 

Remember that Bucket 2 will still need to keep pace with inflation and ideally build sufficiently to survive
periods of downturn. Bonds and bond funds often don’t do much better than inflation, so Bucket 3 growth will be important, especially in the early retirement years. Very conservative investors may put these funds in high-qua­lity bond funds (total bond market or even U.S. government). Some investors will consider a high-yield (junk) bond fund for Bucket 2, but those funds are volatile and behave more like stocks so should properly be considered only for Bucket 3. 

Bucket 3 has the longest horizon. This should be the highest risk investments. It has the longest horizon to grow and may not need to be touched during a market downturn. Since statistically the market is up more than down, this bucket takes advantage of the greater reward inherent in riskier investments, provided that the overall portfolio is diversified.  Fill this bucket with individual stocks monitored carefully for performance, a diversification of stock funds (including perhaps higher-risk, higher-return small-cap, sectors and internationals) and perhaps high yield (junk) bonds. About $800,000 of the initial portfolio will go here. The 4% withdrawal rate depends on the portfolio having at least 50% in the stock market. In this example, cash and bonds (Buckets 1 + 2) hold about 36% of the portfolio; Bucket 3, stock funds and perhaps junk bond funds, constitutes 64% at the beginning. The entire portfolio may move to more conservatism as (and if) Bucket 3 is depleted over the years.

Pouring From Bucket to Bucket

You have at least three options for getting money from Buckets 2 and 3 into your spending Bucket 1.

Take Payouts in Cash
Cash that builds up in Bucket 2 can be transferred periodically to replenish Bucket 1 and cash built up in Bucket 3 can be moved into Bucket 2 if necessary. Given rela­tively low interest rates at the moment, dividends alone probably won’t be enough to fund a 4% spending level. 

In addition, not every year pro­duces enough capital gains. When the total return of the portfolio (gains + income) exceeds the withdrawal rate, some should be “left behind” to tide you over bad markets. If you take everything out of the portfolio and don’t rebalance among funds, you lose the opportunity to buy low and sell high.

Keep Invested, Then Rebalance
This method takes advantage of compounding because you’ll be getting returns on a higher number of shares. But if share prices drop, you might lose the value of reinvested dividends and capital gains, whereas taking them in cash means, well, you’ll have the cash.

For 401(k)s and other tax-deferred retirement accounts, you need to take required minimum distributions after age 70.5. These RMDs alone may be enough to replenish your cash bucket. 
But you don’t necessarily need to cash out investments unless you need the spending. Shares can be transferred from a retirement to a taxable account to meet the RMD. A popular hybrid method is to have dividend distributions mailed as a check or put into the cash bucket, but reinvest capital gains back into the funds in the account.

Real World Problems

Most investors nearing retirement have accumulated more than three buckets! You probably have a savings account or two and your checking account (Bucket 1). Next, there’s a 401(k) or 403(b), an individual retirement account, a Roth IRA, a health savings account and maybe inherited accounts. Finally, you may have a brokerage account including individual stocks. At retirement, management and RMDs will be much easier if you merge accounts into one of each type.

Individual tax situations can impact how you withdraw from accounts, but for many people the account to preserve the longest is the Roth, with no minimum distribution required. The Roth would then be ideally classified as (part of) Bucket 3, with your stock mutual funds, real estate investment trust funds and individual stocks. 

You may not have enough in any given fund to divide perfectly into buckets, so you’ll need to assign specific investments to Bucket 2 or 3. It’s fairly easy to select a (limited) diversity of bond mutual funds and track them as Bucket 2. In fact, it might be even easier to designate two buckets — one for spending for two years, and one for the future. 

In our example, 8% of the portfolio would be in Bucket 1. In Bucket 2, 28% of investments would be in the “safer” side (bond funds) and 64% in the more aggressive investments (stock funds, etc.). This two-bucket system is closer to the more traditional asset allocation system.

In fact, the bucket system somewhat removes the worry regarding proper risk asset allocation and how to construct a diversified portfolio. It’s based more on spending needs and less on risk tolerance assessment. This system may not necessarily produce the maximum possible results of a thorough asset allocation and rebalancing approach, but it’s easier to understand and manage.

Danielle L. Schultz, CFP, CDFA, is a fee-only financial adviser with Haven Financial Solutions.

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