You worked hard during your working years to create a retirement corpus. Now, it is time to deploy the retirement corpus smartly so that you can enjoy the golden years without any financial worries. In this article, we will understand what the 3-bucket strategy for retirement is and how to go about it.
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What is the 3-bucket strategy?
The 3-bucket strategy involves appropriating your retirement corpus into three separate investment buckets to cater to your cash flow needs during different periods of the retirement years. Each bucket is based on a specific time horizon and serves a specific purpose. The strategy ensures you keep getting regular cash flows for your monthly expenses while your corpus remains invested in the three buckets.
The bucket strategy was suggested first in the 1980s by Harold Evensky, a US financial advisor. The three buckets include the following:
1) Liquidity bucket
The liquidity bucket focuses on your cash flow needs in the immediate and short-term, spanning the next 2 to 3 years. It includes your emergency fund, regular monthly expenses, healthcare expenses, etc. The focus here is on liquidity and not on returns. The liquidity bucket is also known as the short-term bucket.
The liquidity bucket money may be maintained in a savings account, a debt fund like a liquid fund, short-term fixed deposits and bonds, etc. If you are getting any monthly pension or other regular income, you may include it in this bucket. The regular income may include dividend from equities and mutual funds, rent from real estate, interest from fixed-income instruments, distributions from REITs and InvITs, etc.
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You can withdraw money from this bucket for monthly expenses and any other contingencies. The liquidity available from this bucket for the next couple of years ensures you give time for your money in the other two buckets to grow. The liquidity bucket must be replenished regularly from the other two buckets discussed below.
With time, your monthly expenses will increase due to the impact of inflation. In such a scenario, you will have to evaluate the balance to be maintained in the liquidity bucket and accordingly increase it from time to time.
2) Safety bucket
Once your immediate cash flow needs for the next couple of years are sorted out, you can focus on planning the next 5 years beyond that. The money maintained in the safety bucket should match or beat inflation. The safety bucket is also known as the medium-term or intermediate bucket.
The focus is on maintaining a balance between liquidity and returns. The safety bucket money may be invested in a mix of equity and debt instruments. Some of these include:
a) Fixed deposits
b) Bonds
c) Hybrid funds, balanced funds, etc.
d) Medium-duration debt funds, corporate bond funds, etc.
e) Government small savings schemes with a tenure of up to 5 years
f) Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs)
g) Alternative investments like P2P lending, invoice discounting, lease financing, etc.
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Some of the financial instruments in this bucket may have a lock-in period. However, you can hold them till maturity, and there is no pressure on you to redeem them earlier as your short-term cash flow needs are being met from the liquidity bucket.
From time to time, the money from the safety bucket must be used to replenish the liquidity bucket. Also, from time to time, the safety bucket must be replenished from the wealth creation bucket discussed below.
3) Wealth creation bucket
The wealth creation bucket focuses on growing your money. In the long run, you can benefit from the power of compounding and generate inflation-beating high returns. The first two buckets, i.e. liquidity (2 to 3 years) and safety (5 years), address your needs for the next 8 years. The wealth creation bucket addresses your needs beyond 8 years. The wealth creation bucket is also known as a long-term bucket.
The wealth creation bucket money may be invested in long-term wealth-generating instruments like:
a) Equity funds: These can include active and passive funds, sectoral and thematic funds, smart-beta funds, etc.
b) Real estate
c) Long-term debt instruments
d) Gold, etc.
Equity, gold, etc., can be volatile in the short term and undergo big corrections. However, there is no pressure on you to redeem/sell as your short-term cash flow needs are being taken care of from the other two buckets. As a result, you need not panic; wait for the equity markets or gold prices to recover and start growing your wealth again. Real estate is illiquid. However, you can take your time to find the right buyer at the right price, as your short-term cash flow needs are being addressed from the other two buckets.
Since the liquidity and safety buckets can take care of your financial needs for the next eight years, you can allow time for the growth assets to create wealth for you. From time to time, the money from the wealth creation bucket must be used to replenish the safety and liquidity buckets.
Combining 3-bucket strategy with other strategies
Everybody's needs are different. Hence, the 3-bucket strategy may not suit everyone's needs. Therefore, an individual may customise or combine the 3-bucket strategy with other strategies and frame one that suits their requirement. While following the 3-bucket strategy or any other, an individual must ensure they have an adequate amount of health insurance coverage. Some individuals may be suffering from a lifestyle disease like diabetes, high BP, etc., that requires regular doctor visits, diagnostic tests, medicines, etc. In such a case, an individual should make a provision for these expenses in the liquidity bucket.
Enjoy your golden years without any financial worries
In the 3-bucket strategy, the short-term focus is on liquidity, the medium-term focus is on a balance between liquidity and returns, and the long-term focus is on wealth creation. You can get the required regular cash flow for monthly expenses in the short term and earn good returns on the corpus in the long term. Thus, with the 3-bucket strategy, you can make the best use of your retirement corpus and sail smoothly through your golden years.
Gopal Gidwani is a freelance personal finance content writer with 15+ years of experience. He can be reached at LinkedIn.
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