Retirement planning is not just about when to take retirement benefits. It is also about how much to take. You can use many methods to create a stable income flow for retirement planning.
If you’re planning for retirement, you’ve probably heard of bucket retirement planning. But what exactly is it? How does it differ from systematic withdrawals? What are the pros and cons of each approach? Let’s take a look!
Bucket retirement planning involves using a set of funds to invest in several asset classes. These funds are dedicated to a specific portion of your portfolio, which is referred to as a ‘bucket’. This bucket is then used to make investments in different markets, including stocks, bonds, and cash.
As a result, your investments are diversified into different asset classes. Your consumption will be from a single bucket, but you’ll have a variety of investment options to choose from. With bucket retirement planning, you have complete control over the amount of money you take out every year. This allows you to invest your funds in stocks and other risky assets if you choose to. However, you’re also able to keep a portion of your funds in safer investments, such as bonds, to ensure you won’t run out of money if the stock market dives.
A systematic withdrawal method takes money from your retirement fund. All of your assets are treated equally in this method, and you receive a monthly income from them. The systematic withdrawal technique can be used to liquidate or sell investments proportionally to fulfil income demands. This helps maintain a balanced asset allocation across mutual funds and other sub-accounts. According to a famous 1994 research by Bill P. Begen, a retiree should take four to five per cent of their savings annually.
Systematic withdrawals are easier to manage and more predictable over time. However, investors struggle with this method during a market downturn or correction. They may grow concerned when the value of their retirement account decreases, leading to risk aversion and poor decision-making.
Bucket retirement techniques are a great solution to address this issue. Because short-term investments are stored in cash or other liquid assets, a market collapse may only affect long-term “buckets” that retired individuals would be less worried about.
Similarly, retirees may have invested the same amount, but giving different labels to accounts might encourage them to take on varying degrees of risk.
These psychological advantages of bucket retirement planning may reduce panic-driven judgments.
Bucket and systematic withdrawal methods are comparable in terms of portfolio allocation and performance. Although one can use different bucket portfolio allocation techniques in other circumstances, the asset allocation mix of these strategies is similar. For example, person A may have 60% cash and short-term debt options in the first two buckets and 40% in equities in the last two buckets. In that case, it is a mix of 60/40 ratio between income and growth.
In principle, the bucket approach and systematic withdrawal method are comparable, since their asset allocations are pretty similar. However, there is a significant difference between these two techniques in practice because of investors’ cognitive biases. Investors are typically more comfortable with market drops and proper risk-taking when using a bucket approach than a standard systematic withdrawal strategy.
You can talk to your financial advisor to know more.
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