#34 | Use the Buckets of Money strategy for retirement income

Jon “Jag” Gay: Welcome to Protecting and Preserving Wealth. I am Jon Jagay and to tell our listeners how dedicated Bruce Hosler is to communicating important information to you regarding your financial future and your retirement, he is up at 7 a.m. his time to record with us today. Welcome, Bruce.

Bruce Hosler: Thanks, Jon.

Jon: A little bit easier for me here in Eastern Time, it’s 10 here. Bruce, what are we sharing with our listeners today?

Bruce: Jon, I want to remind our listeners that they can improve their chances of success in retirement by protecting their retirement income in volatile markets and they can do that by using the buckets of money strategy to set up retirement income ladders.

Jon: I know a lot of people are worried right now with the volatility. We’ve seen in the stock market over the last few years. We’re recording on October 31st. You’ve got the wars going as we record here in Ukraine and Israel, inflation we’re experiencing. A lot of people understandably pretty unsettled, Bruce.

Bruce: That’s why we need to discuss this topic today because it’s very pressing in everybody’s minds. In 2022, both the stock market and the bond markets lost value at the same time. Now, this doesn’t happen very often as those two asset classes are usually non-correlated, meaning that they don’t usually lose money at the same time. Clearly though, one of the biggest risks that retirees face is sequence of return risk.

Jon: I’ve heard that phrase here and there but need a better understanding of it, Bruce. What is sequence of return risk?

Bruce: Sequence of return risk is when a person enters retirement and begins to take distributions out of their investment portfolios to support their retirement income needs and then at the same time early in their retirement years, the investment markets that they’re invested in, whether it be stocks or bonds or real estate or commodities, lose value in a significant fashion early in their retirement. When that happens, the retiree is experiencing sequence of return risk early in their retirement years. They can find themselves withdrawing income and then losing money on their investments at the same time. That can be catastrophic to a person’s retirement.

Jon: That’s a $3 word right there, Bruce. When you say catastrophic, does that mean they could potentially run out of money in retirement?

Bruce: Jon, that’s exactly what it means, and that’s what’s most important to our listeners who are trying to avoid this running out of money in retirement fear. That is a risk that can be managed through investment selection, asset allocation, and using the buckets of money approach to create income ladders appropriate to your income needs from your portfolio.

Jon: A lot of information, a few different things you listed off there, Bruce. Investment selection, asset allocation, and the buckets of money approach to create income ladders. Let’s unpack each one of those. Let’s start with the buckets of money approach.

Bruce: The buckets of money approach is a financial retirement planning strategy where you break your investments into different buckets of money based on the period of time that you may need the funds in that particular bucket for income. For example, we use four buckets of money. Bucket one is for years one through five of your retirement. Bucket number two is for year six through ten. Bucket number three is for years 11 through 15 and bucket number four is for years 16 through 20.

Jon: You’re segmenting a client’s portfolio for the period of time that they’ll need income from a particular bucket, is that right?

Bruce: That’s exactly right, Jon. Each bucket is set up to receive and disperse income during its specific period of time. Each bucket should be invested differently. Let me explain in other words. In order to avoid losing money from the same bucket that you’re taking money from in the first five years of retirement, your first bucket should be invested in very conservative fixed-income type investments that are not going to lose a big percentage in the markets at the time that you’re taking income out. On the other hand, when you have income that you’re not going to need for ten years or more, buckets three and four should be invested in investments that have the potential to give you growth in order to stay ahead of inflation. Those buckets would likely be invested in investments that may be volatile over a period of time, but they’re going to provide you with the opportunity for a potentially higher rate of return, helping you provide future inflation-adjusted income that you’re going to need in the future.

Jon: Bruce, I know we’ve talked in previous episodes about investing differently based on where you are in your working years. If you’re say in your 20s versus your 50s, it seems that you’re talking about the same thing for the retirement years. What I’m hearing is buckets one and two are usually invested in conservative safe type investments that if the market drops 20%, income is not really affected at all.

Bruce: That’s right, Jon, because the investments that those buckets are invested in are more conservative and should not experience the volatility that longer-term growth-oriented investments should.

Jon: Then longer-term investments like buckets three and four, they need to be invested in such a manner that they can keep up with inflation and provide a higher rate of return in order to provide our listeners with future income greater than the inflation we’re experiencing today.

Bruce: That’s right, and that’s the goal. In the near term, we’re not so worried about inflation, but as time progresses, a retiree has to make sure that they’re going to be able to stay ahead of and generate inflation-adjusted income ladders.

Jon: Okay, Bruce, so when you were speaking of asset allocation earlier, it seems to me you meant that the right type of asset should be invested in the right bucket of money depending on when we’re going to need that income from that bucket. How does that work with an IRA account?

Bruce: We have a simple way of creating clarity for our clients in such a circumstance. Frequently, we will divide the IRA into two accounts. One account we will title income IRA account and the second one we will call a growth IRA account. By splitting the IRA into two accounts like this, our clients can clearly see which account they can expect to take withdrawals from for the current income and which account will be invested more aggressively for growth in the future that we will not be using for current income. As you can imagine, buckets one and two are invested conservatively. Usually, they will provide a more stable value as well as providing stable income in the near term.

On the other hand, the IRA invested for growth may experience some volatility, but the client can clearly see that they have 10 years until they’re going to need any income from that growth bucket of money. This will give them the comfort knowing that they have the ability to wait and stay the course even though the markets may be volatile.

Jon: Bruce, this strategy seems like it’s going to help people to avoid panicking when the markets become volatile because that money is not going to be needed till later on down the road.

Bruce: That’s exactly what it does, Jon. It clearly demonstrates for them to see the money that they are not going to need for 10 years may go up and down in value, but over the long term will generally provide them with more growth that they will need and want to sustain their inflation-adjusted income in the future.

Jon: This all sounds great, Bruce, but are there any downsides to this strategy?

Bruce: Certainly, the stock market does not always cooperate with our best-laid plans. For example, last year in 2022, even into this year in 2023, some of the equity markets have not grown to their expected historical performance. Those time periods where the markets are underperforming make it hard for clients to believe that the markets will ever return to normal if there is even such a thing.

Jon: Yes, normal. Do you ever split up taxable accounts and title them growth or income accounts as well so the client can see that you’re investing in their portfolio using this strategy?

Bruce: Yes, we do, and that can also provide some additional clarity and comfort to clients knowing that one account, even though it’s a taxable account, is their current income account, and the other account, which is a longer-term account, is set up as long-term growth account and will be invested totally different using longer-term growth-oriented investment vehicles.

Jon: Bruce, I know you’re a big fan of creating tax-free income and that Roth IRAs and Roth Conversion IRAs play a big part in your planning for clients. How do these types of accounts fit into the buckets of money income strategy?

Bruce: Jon, as I finished my new book, Moving to Tax-Free, and hopefully it will be released early in 2024, and in researching that book, I became convinced that our tax rates are likely going to double over the next 10 years in the United States. I know that sounds very dramatic, but because of that, I am a big fan of helping clients move their investments to tax-free vehicles, and my view is that tax-free vehicles like Roth IRAs and Roth Conversion IRAs are some of the most sacred money and important funds that our clients have saved for their retirement.

Generally speaking, these funds should be used last so that they can provide a bigger shelter from the coming fiscal tax crisis that our country faces. If tax rates double, as I expect them to in the next 10 years, using a Roth IRA to shelter your taxable income from 40%, 50%, or even 60% tax rates will become an important protection from the tax storm that is most certainly coming. We are usually recommending that clients hold these type of accounts in buckets three or four.

Jon: That makes sense for later on down the road, as you said, using them last. If listeners have questions about using the buckets of money income ladder strategy, how do they find you and your team at Hostler Wealth Management, Bruce?

Bruce: Jon, the best way for them to reach us is at our website at https://hoslerwm.com, or they can call us in Prescott at 928-778-7666, or in Scottsdale at 480-994-7342. Great podcast today, Jon. Thanks for your help.

Jon: Securities and advisory services offered through Commonwealth Financial Network, member of FINRA/SIPC, a registered investment advisor. Forward-looking commentary should not be misconstrued as investment or financial advice. The advisor associated with this podcast is not monitored for comments and any comments should be given directly to the office at the contact information specified.

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