The ‘Evensky method’ bucket list that can secure your future

Harold Evensky’s approach divides your priorities up into “buckets”.

Growing up during the vibrant 1970s and ’80s, I vividly recall not just the iconic brown bell-bottomed jeans that were my favourite (always worn with sandals and socks) but also the notably superior interest rates for retirees.

Think back to 1981 when, thanks to wild inflation, a six-month term deposit earned an annualised interest rate of 11.6 per cent. Such rates, combined with more economical prices for cars and houses, allowed many retirees to lead a comfortable life without touching their principal savings.

Fast forward to today, and those golden days of cheap goods, high interest rates and distinctive fashion feel like ancient history.

1970s rates of return were better but the fashions were questionable.

Modern pre-retirees must grapple with concerns about their nest eggs, aware that they might need to tap into some of their capital to supplement the income not met by earned interest.

Regardless of the size of your savings, today I aim to shed light on constructing a retirement fund, spotlighting a particular strategy that might soothe retirement-related anxieties.

Let me introduce the “bucket approach” for retirement planning, conceived by esteemed US financial adviser Harold Evensky.

Known as the “dean of financial planning”, Evensky is the author of the books Wealth Management and Long Term Health Care.

The bucket approach gives retirees a road map to optimise their wealth, ensuring a steady income, well into retirement. It is based on a straightforward yet powerful idea: money reserved for immediate costs should stay in cash, regardless of the returns. The readily available funds in the first bucket act as a safety net, letting retirees navigate the unavoidable ups and downs in their investment journey.

This approach also shields against “sequencing risk” – the danger of a steep decline in asset values at the start of one’s retirement, which is something I have written about before.

Because retirees, no longer actively earning a wage, must make regular fixed withdrawals from their retirement savings, volatility becomes an enemy.

If the entire retirement fund is tied up in volatile assets, a market dip could amplify the impact of regular withdrawals. During a market downturn, the retiree is forced to sell more units at lower prices to meet the withdrawal requirements, depleting the portfolio faster and leaving fewer assets available to recover the losses.

To counter this, one sets aside the cash estimated for day-to-day needs and probable recovery times from market slumps, forming the retirement bucket list.

Bucket one: Immediate expense reserve

At the heart of the bucket approach lies a fund dedicated to meeting short-term costs, perhaps for two or three years. Even in today’s low-yield environment, this bucket’s primary goal is to cover immediate costs not satisfied by other revenue streams.

To determine the right amount for this bucket, calculate your yearly expenses and subtract guaranteed incomes, like pensions. The remaining amount is what’s needed from this bucket. A cautious individual might even include some emergency funds. If there’s not enough, lifestyle changes need to be made. To maximise returns, consider splitting this bucket: one part as pure cash for the immediate year’s expenses, and the rest in higher yielding cash alternatives, like term deposits.

The remaining buckets two and three: Diversifying the strategy

In practice bucket two tends to be less conservative than the first but more conservative than bucket three.

Its purpose is to offer medium-term stability to fund bucket one’s future years. This bucket embodies five or more years of anticipated expenses, focusing on consistent income generation. It typically contains solid income-generating assets, and investors might want to consider the emerging private credit asset class, which can generate stable monthly income at rates as high as 9 per cent per annum. Returns from this segment can be used to refill bucket one, and occasionally even bucket three.

This long-term bucket three contains assets like equity funds and alternative investments. While it offers substantial growth potential, it also carries risks. Hence, buckets one and two play a pivotal role, preventing rash withdrawals during market troughs.

At the end of every year the three buckets are rebalanced with the sole objective of starting a new year with two to five years’ lifestyle income needs in bucket one.

A new approach

Here’s how to approach this. A first step would examine the investment returns in buckets two and three. Depending on performance, there are three possible results. perhaps both buckets produced a positive result, or both produced a negative result, or one bucket produced a positive return and the other negative.

A second step is to withdraw from the bucket(s) with a positive return sufficient funds to meet the objective set for bucket one – that it has two to five years of income needs at the start of each year.

The bucket with a negative year remains untouched. If both buckets are negative, they both remain untouched.

This is the reason the cash bucket has two to five years’ income needs at the commencement of the strategy so that the retiree can ride out the dips.

The importance of buckets one and two to the strategy, and the possibility of a negative scenario in both buckets, make quality income funds attractive. The best private credit funds offer monthly cash returns and have experienced no negative months for many years.

If the cash balance in bucket two at the end of any year is less than two years’ worth of income requirements, an alternative approach is required.

Again, there are three possible scenarios for buckets two and three. The first is that both buckets produced a positive result. The second is that both produced a negative result, and the third is that one bucket produced a positive return and the other a negative one.

Any positive earnings in either of the investment buckets up to the end of the year in question go into the cash bucket. And any investment bucket with negative earnings remains untouched unless the balance in bucket one remains below two years’ required income.

In that scenario, equal amounts are drawn from buckets two and three, irrespective of their earnings, to replenish the cash bucket so that it begins the year again with two years’ income requirement.

The bucket approach might not be everyone’s cup of tea. It demands planning, discernment in asset allocation, and discipline. Engaging an adviser could be beneficial.

Roger Montgomery is founder and chief investment officer at Montgomery Investment Management