The bucket strategy is a retirement investment approach that investors use to split their portfolio into two or three buckets, based on spending and investing timeframes. Tantalisingly, it claims to allow you to avoid selling growth-oriented investments to cover spending in potentially unfavourable market conditions. But it’s fundamentally flawed.
Under the bucket strategy, each bucket is aligned with its respective time horizon. The immediate spending bucket consists of cash, the intermediate bucket consists of bonds and the long-term bucket is primarily invested in growth assets. It’s heavily promoted on Facebook, Reddit and by influencers as a method that enables investors to enjoy higher long-term returns without compromising their ability to meet short-term expenses. However, it involves market-timing decisions about when to replenish buckets, prevents investors from taking advantage of buying opportunities during market declines, and causes the portfolio’s risk allocation to drift lower over time (at a time when it arguably should be increasing as the Age Pension becomes a larger portion of the portfolio).
Javier Estrada, a professor of finance at the IESE Business School in Barcelona, Spain – who specialises in portfolio management, risk management and wealth management – published a detailed analysis of it in his 2018 paper titled ‘The Bucket Approach for Retirement: A Suboptimal Behavioural Trick?’ He concluded that:
“Ultimately, the evidence shows that a bucket approach underperforms static strategies … For this reason, however plausible, comforting, consistent with mental accounting, and easy to implement the bucket approach may be, simple static strategies, which call for periodic rebalancing and are just as easy to implement, would make retirees better off.”
On the plus side, it may enable retirees to psychologically accept a higher overall level of risk than they otherwise might. It’s also likely to yield better results than simply withdrawing a pro rata amount from each asset class, as you would with the multi-asset options offered by most of Australia’s higher profile public-offer funds. Think of this as the reverse of dollar cost averaging, which works with you in accumulation but against you in retirement.
However, this psychological illusion comes at a high price. That price will be realised in lower retirement incomes, a reduced legacy and/or need to save more during your working life, or to defer retirement until later in life.
Why it’s a flawed strategy
The bucket strategy is market timing in disguise. Investors must decide when to refill the cash and medium-term buckets as they deplete. The sales pitch is that investors can avoid doing so during market declines. But how is the investor to know when the market has bottomed? The evidence shows that investors can’t consistently make these calls correctly.
It may work reasonably well in short-term declines such as the 2020 collapse at the start of the pandemic, where the ASX 200 regained its February 2020 highs by April 2021 (on a total return basis), or the ‘Liberation Day’ fall in April 2025, where markets recovered within 30 days. But it doesn’t handle the falls that can truly wreak havoc on a retirement plan well. These are the deep and prolonged ones, such as the 2008 GFC, when the ASX 200 (in price terms) fell 51 per cent from its November 2007 high, bottomed in March 2009 and took until July 2019 to fully recover. It is extraordinarily difficult to predict what type of decline you’re facing until it fully unfolds.
You don’t take advantage of market declines to buy assets cheaply
The bucket method doesn’t provide a mechanism for buying assets at depressed prices. Funds only move from high-risk to low-risk buckets as investors replenish their cash buffers. In contrast, a risk-based approach uses rebalancing to buy more growth assets during downturns. So, while bucket-based investors were sitting on the sidelines in 2008 and 2009, wondering when to sell equities to replenish their cash bucket, risk-based investors were selling gold and bonds (both of which went up) and buying the ASX 200 at bargain prices.
Your portfolio risk varies over time
Asset allocation – the mix of cash, bonds, shares, real estate and infrastructure – accounts for as much as 90 per cent of a portfolio’s risk and return. A risk-based strategy keeps this consistently aligned with your risk profile. This way, you maximise long-term returns for any level of risk you can tolerate. With the bucket method, in contrast, when markets fall, the growth portion shrinks, and the defensive share rises – just when growth assets are cheapest. When markets boom, growth assets tend to rise, which can increase risk at high valuations. This is the opposite of prudent portfolio construction.
Your portfolio becomes increasingly conservative over time
As you spend down your portfolio over retirement, a year’s spending becomes a larger share of your remaining assets. Fifteen years into retirement, your 3-year cash bucket may represent 30 per cent of your remaining funds (up from 15 per cent) and your conservative bucket a further 50 per cent (up from 25 per cent). Your portfolio may now be 80 per cent defensive – insufficient to provide inflation-linked income over the long haul (at the same level of certainty). Ironically, this often occurs when your Age Pension becomes a larger share of your income and net assets. That shift should allow you to take on more risk – not less.
This is an edited extract from 12 months to retire right: The step-by-step guide to build wealth and retire on your terms by Glen James & Vince Scully (Wiley, $36.95), available at all leading retailers.
Disclaimer: The information contained in this article is general in nature and does not take into account your personal objectives, financial situation or needs. Therefore, you should consider whether the information is appropriate to your circumstances before acting on it, and where appropriate, seek professional advice from a finance professional.
