Retirement should be a time of relaxation and enjoying the fruits of years of hard work. However, once you have built up a good retirement corpus, the challenge shifts to managing that money so it lasts as long as you do. A smart way to do this is by using a bucketing strategy. This strategy divides your total savings into different “buckets” that are tailored for your short-term, medium-term, and long-term needs. By doing so, you can cover your everyday expenses while still allowing your investments to grow and fight against the effects of inflation.
In this blogpost, let’s understand how bucketing strategy works and how you can design and manage these buckets to secure a stable income throughout your retirement years.
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Understanding the Bucketing Strategy
Imagine your retirement savings as a large pie that you need to cut into several pieces. Each piece, or bucket, has its own purpose. Some of these pieces are meant to cover your immediate needs, while others are set aside to grow over time. The main idea is that if you plan carefully how to spend and invest your money, you will not run out of it even if you live many more years than you planned for.
Many retirees are tempted to spend their large nest egg quickly on travel, luxury homes, or a lavish lifestyle. Even though having a big sum of money can be exciting, it is important not to assume that the struggle is over once you retire. In fact, building a substantial corpus is only half the challenge. The other half is about how you allocate your savings so that you have enough money every month and your overall fund continues to grow. This balanced approach is what the bucketing strategy is all about.
When you retire, you typically stop earning a regular income. This makes it essential that your retirement savings are organized in a way that produces a steady stream of cash flow while also protecting your future financial security. The bucketing method helps you plan for unexpected expenses, like medical emergencies, and takes inflation into account so that the buying power of your money does not diminish over time.
How to Create Your Buckets
The first step in using a bucketing strategy is to figure out how much money you need for your daily living expenses now and in the future. When you do this, consider your lifestyle, cost of living, health care needs, any debts you might have, and other sources of income. Although you can create as many buckets as you want, most financial experts suggest dividing your savings into three main buckets.
Bucket 1: Short-Term Needs
The first bucket is meant to cover your cash needs for the near future, typically from one and a half to three years after you retire. This bucket should be kept in very liquid or easily accessible forms of money. Think of instruments such as liquid funds, short-term fixed deposits, treasury bills, or arbitrage funds. The focus in this bucket is not on high returns but on safety and availability.
The idea is to refill this bucket every three to six months, ensuring that there is always enough cash to cover your immediate expenses. It is a good idea to review how much money is in this bucket at regular intervals, adjusting for factors like inflation or any changes in your spending habits.
Some financial advisors also suggest maintaining a separate “capital growth” bucket, which is reserved only for long-term capital appreciation and is not tapped for everyday spending. This extra layer helps safeguard your savings and keeps your primary buckets focused on their specific goals.
Bucket 2: Medium-Term Needs
Once you have secured your immediate cash flow, the next step is to build a medium-term bucket. This bucket covers a period of about three to five years after retirement. The goal here is to strike a balance between earning moderate returns and reducing risks. Investments in this bucket might include conservative hybrid funds, equity savings funds, balanced advantage funds, or even government-backed schemes like the Senior Citizens Savings Scheme (SCSS). The money in this bucket helps generate returns that can be used to refill the short-term bucket whenever it starts to run low.
The medium-term bucket acts as a bridge between the need for quick cash and the goal of long-term wealth growth. By investing moderately here, you ensure that even if the short-term funds are depleted, you can replenish them without dipping too much into your long-term savings. The returns from these investments are generally stable, which gives you confidence that you have a backup source of income during your retirement years.
Bucket 3: Long-Term Growth
The third bucket is designed for the long haul. This bucket should cover cash needs that extend 10 years or more into the future. Its primary objective is to generate returns that outpace inflation. Over the years, inflation can significantly erode the purchasing power of your money. For example, if your current monthly expenses are a certain amount, they will grow substantially over time due to inflation. The long-term bucket is where you can invest in instruments with a higher potential for growth, such as equity funds, flexi-cap funds, multi-cap funds, or diversified asset allocation funds.
Because this bucket is intended to last for many years, you can afford to take on a bit more risk here. Even if the returns fluctuate in the short term, the long-term growth of these investments can provide a cushion against inflation and help your savings grow significantly over time. Experts often advise that only about one-third of your total retirement assets should be allocated to equities. This approach helps balance the need for growth with the need for stability, ensuring that you have both safety and the opportunity to earn higher returns during good market periods.
How to use and manage the Buckets
Creating the buckets is only part of the strategy; managing them well over time is crucial. A clear withdrawal plan is essential so that you do not fall into the trap of overspending early on. Financial planners typically suggest that you withdraw no more than 4-6 percent of your total portfolio’s value each year. For example, if your investments return 7 percent per year, a withdrawal rate of 5 percent might be ideal. This way, you can use the returns to replenish your short-term bucket while also allowing your long-term investments to grow further.
The key is to maintain a balance. If your withdrawals exceed the returns generated by your investments, you will have to dip into your principal, which will reduce the size of your overall corpus. Over time, this can lead to a situation where your funds run out, leaving you financially vulnerable. Conversely, if your investments earn higher returns, your savings will grow, and you can enjoy a comfortable retirement without worrying about depleting your funds.
An Example of this Bucketing Math
Let’s take a practical example. Imagine you have a retirement corpus of ₹1 crore. According to a common allocation strategy, you might divide it into three buckets: 10 percent (₹10 lakh) for short-term needs, 40 percent (₹40 lakh) for medium-term needs, and 50 percent (₹50 lakh) for long-term growth. In the short-term bucket, assume you invest in liquid assets earning about 6 percent per annum. The medium-term bucket could be placed in conservative hybrid or equity savings funds with an expected return of around 8.5 percent annually, while the long-term bucket might be invested in more aggressive hybrid funds yielding approximately 10.5 percent.
When these investments are combined, the overall weighted return might come out to about 9.25 percent per year. Now, let’s say inflation is running at 6 percent annually, and your current monthly expenses are ₹50,000. Under these conditions, calculations might show that your funds could last for around 23 years. However, if you need your savings to stretch over 30 years, you may have to adjust your monthly spending to around ₹42,500. These figures illustrate how important it is to run the numbers carefully so that your withdrawals are sustainable over the long term.
Regular Rebalancing of your Buckets
Even with a well-planned strategy, you must revisit and adjust your buckets periodically. For instance, if the money in your short-term bucket starts to dwindle, you might need to transfer funds from your medium-term bucket to keep your liquid cash level stable. Similarly, if the long-term bucket grows beyond its target, you may want to move the extra funds into the medium-term bucket. This process of rebalancing ensures that each bucket maintains its purpose and that your overall portfolio remains aligned with your financial goals.
A practical approach might be to review your portfolio at least once a year. At the start of each year, check your bucket balances and see if any adjustments are needed based on changes in your expenses, market performance, or unexpected events such as medical emergencies. For example, at the beginning of the fifth year, you might notice that due to inflation, your monthly expenses have increased from ₹50,000 to around ₹63,000.
In response, you would need to adjust your withdrawals and possibly shift some funds among the buckets to cover the increased costs. Over a period of 10 or 15 years, as your expenses continue to rise, your careful monitoring and rebalancing will help ensure that your savings are not depleted too quickly.
A closer look at Bucket Transfers
To understand bucket transfers better, imagine this scenario: Initially, you allocate ₹10 lakh to your short-term bucket, ₹40 lakh to your medium-term bucket, and ₹50 lakh to your long-term bucket. As you withdraw funds to meet your monthly expenses, the short-term bucket begins to shrink. Once it reaches a lower threshold, say, half of its initial amount, you then transfer money from the medium-term bucket to refill it.
At the same time, if your long-term bucket exceeds its designated limit because of strong market returns, the excess can be shifted to the medium-term bucket. This ongoing process of transferring funds between buckets helps keep your cash flow steady while allowing the overall portfolio to grow steadily over time.
In one detailed illustration, over a span of 60 months, the short-term bucket might be refilled several times from the medium-term bucket. Every time the short-term fund drops below its target level, a corresponding amount is moved from the medium-term fund. Similarly, when the value of the long-term investments grows beyond a set limit, the surplus is shifted to the medium-term bucket.
In one example, a total of about ₹25 lakh might be transferred over a period of 60 months, allowing the overall portfolio to maintain balance. At the end of these 60 months, the short-term, medium-term, and long-term buckets have adjusted to new levels that reflect both the withdrawals for expenses and the gains from investments, all while keeping the portfolio’s weighted average return close to the target rate.
Managing your Retirement Corpus for Longevity
One of the most important lessons of the bucketing strategy is that retirement planning does not end when you stop working. Just as you had to manage your finances carefully during your working years, you must continue to do so in retirement. The idea is to ensure that your investments are managed as rigorously in retirement as they were during your accumulation phase. This means planning withdrawals carefully, monitoring the performance of each bucket, and being ready to adjust your strategy if market conditions or your personal needs change.
For example, if you find that your monthly expenses are beginning to exceed the returns from your portfolio, you might have to take money from your reserve funds. This could reduce the principal and lower the overall returns in the future. In such cases, it is crucial to adjust your lifestyle or re-examine your investment strategy to prevent depleting your corpus too quickly. Remember that even a slight miscalculation in the early years of retirement can have serious consequences later on.
Another factor to consider is the possibility of unexpected expenses. As you age, the likelihood of needing extra funds for medical emergencies, home modifications, or other unforeseen costs increases. This uncertainty reinforces the need for a well-planned bucketing strategy. By setting aside funds specifically for short-term emergencies, you can avoid having to liquidate long-term investments at an inopportune time.
Long-Term Security and Flexibility
Ultimately, the bucketing strategy is about achieving a balance between security and growth. The short-term bucket offers immediate security, ensuring that you always have enough liquid cash to cover daily needs. The medium-term bucket acts as a buffer that can replenish the short-term funds and provide a steady stream of income. The long-term bucket, meanwhile, is designed to grow your wealth over time, protecting against inflation and giving you the flexibility to handle major expenses later in life.
This balanced approach not only helps you meet your current needs but also secures your financial future. By dividing your savings into these buckets and rebalancing them periodically, you can reduce the risk of running out of money and ensure that you have enough to enjoy your retirement years fully. It is a strategy that demands regular attention and careful calculation, but the reward is the peace of mind that comes from knowing you are prepared for whatever the future holds.
Final Thoughts
Retirement planning is filled with uncertainty, and the bucketing strategy offers a structured way to handle that uncertainty. Rather than being overwhelmed by the idea of managing a large corpus of money, you break it down into manageable parts, each with its own purpose and timeline. This bucketing strategy allows you to spend confidently in the early years of retirement while still preserving the capital needed for the later years. It is a dynamic system that evolves with you, ensuring that your retirement corpus remains robust regardless of how long you live or how your financial circumstances change.
In summary, the bucketing strategy is not just about dividing your money, it’s about thoughtful planning and disciplined management. It is a tool that helps ensure your savings last, so you never have to worry about running out of funds in your later years. With careful planning, periodic reviews, and a willingness to adjust your strategy as needed, you can achieve a retirement that is not only comfortable but also financially secure.
You can also check my other blogpost on the cost of delaying your retirement planning and how you can avoid by starting it early.
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