If you are saving for retirement and you do not want to get concerned when unavoidable crashes like 1987, 2000, and 2008 eat into your savings, then you should follow the 2-bucket strategy of Harold Evensky.
Basically, if you don’t have a cash buffer going into retirement and you have the unfortunate luck of retiring during a market downturn, you risk losing a significant portion of your portfolio having to sell stock during this market downturn to cover basic living expenses. The longer lower stock prices last, the more impact it has on your long term retirement pay-outs, having to liquidate portions of your portfolio at these lower prices to pay for day-to-day expenses.
35 years ago, financial advisor Harold Evensky came up with a simple 2-bucket strategy, which seems still one of the best ways to guarantee retirement income. The 2-bucket strategy works is like this:
Split your portfolio into two parts: 1. cash reserve and 2. long-term investments. The cash reserve funds your next 5 years of cash needs, and the long-term investments is typically filled with higher risk, higher return investments. Choose a 5 year period because that’s roughly an economic cycle. From peak to peak a cycle lasts around an average of 5 1/2 years. Your 5 year cash reserve should be enough to get you through a bear market, correction or recession, without risking your portfolio. The cash bucket is meant to complement Social Security, your pension, and any other guaranteed income you receive. Set this up is with a monthly payment from your cash reserve.
Depending on how well your investment portfolio performs, you may decide to fill up your cash reserve before the 5 year mark. This is typically the case when your portfolio performs above average.
Keep you cash reserve in Money market accounts, high-interest savings accounts, CDs or short term bond funds.
Nobody is happy after a crisis like 1987, 2000 or 2008 but if you are prepared for such black swan events you will be emotionally fine with the volatility in the stock market. The nice thing about the 2-bucket strategy is, that it does the job of mitigating risk and it does not overcomplicate things. Building your 2-bucket strategy is easy to follow.
Sven Franssen