• Most Aussies want to retire early
  • There’s a simple rule of thumb to working out how much capital you will need
  • Morningstar’s Christine Benz explains the Three-Bucket approach to portfolio management


Retirement planning may be the furthest thing from your mind but if your retirement age is still far away, you’re in the best possible position to start planning now.

There’s a simple rule of thumb to working out how much capital you will need if you don’t want to use up your savings when you retire:


20x your desired annual income


This means that someone seeking, say $100k a year in retirement, would need $2 million in assets.

The assumption used here is that you will earn 5% per year on your assets through investing, after inflation.

Morningstar’s director of personal finance and retirement planning, Christine Benz, says that with low yields paid on money market accounts, retirees’ choices are quite stark these days:

“To be able to afford retirement, they can plan to delay the date, save more, reduce their standards of living, or take more risks with their portfolios,” Benz said.

Benz recommends that people look into the Bucket Approach to retirement-portfolio management, which was pioneered by financial-planning guru Harold Evensky.

The Bucket concept is anchored on the basic premise that assets needed to fund near-term living expenses ought to remain in cash and low-but-safe yielding assets.

“Meanwhile, assets that won’t be needed for several years or more can be parked in a diversified pool of long-term holdings, with the cash buffer providing the peace of mind to ride out periodic downturns in the long-term portfolio,” said Benz.

She explained that there are three main buckets in her retirement strategy:


The All-Important Bucket 1

The linchpin of any Bucket framework is a highly liquid component to meet near-term living expenses for one year or more.

This means putting some money into cash, safe bonds, term deposits and the like.

“Cash yields are extremely low here, so Bucket 1 is by no means a return engine,” explained Benz.

The goal of Bucket 1 is not to make good returns, but to stabilise your principal to meet income needs not covered by other income sources.

To arrive at the amount of money to hold in Bucket 1, start by sketching out your annual spending needs.

Subtract from that amount any certain, non-portfolio sources of income such as Social Security or pension payments.

The amount left over is the starting point for Bucket 1, i.e. that’s the amount of annual income Bucket 1 will need to supply.

A retiree might also consider including an emergency fund within Bucket 1 to defray unanticipated expenses such as car repairs, additional healthcare costs, and so on.

“More conservative investors will want to multiply that figure by two to determine their cash holdings needed in Bucket 1,” she said.


Bucket 2

Under Benz’s framework, Bucket 2 should contain five or more years’ worth of living expenses, with a goal of income production and stability.

Thus, Bucket 2 should be dominated by high-quality fixed-income exposure, though it might also include a small share of high-quality dividend-paying equities and other yield-rich securities.

“Income distributions from this portion of the portfolio can be used to refill Bucket 1 as those assets are depleted,” Benz said.

But why not simply spend the income proceeds directly from Bucket 2, and skip Bucket 1 altogether?

“Because most retirees desire a reasonably consistent income stream to help meet their income needs,” said Benz.

“If yields are low, the retiree can maintain a consistent standard of living by looking to other portfolio sources, such as rebalancing proceeds from Buckets 2 and 3, to refill Bucket 1.”


Bucket 3

The longest-term portion your portfolio should be in Bucket 3.

This Bucket should be dominated by stocks like small caps and more volatile bond types such as junk bonds.

This Bucket is likely to deliver the best long-term performance, but it will require periodic trimming to keep the total portfolio from becoming too equity-heavy.

“By the same token, this portion of the portfolio will also have much greater loss potential than Buckets 1 and 2,” said Benz.

“Those portfolio components (Bucket 1 and Bucket 2) are in place to prevent the investor from tapping Bucket 3 when it’s in a slump, which would otherwise turn paper losses into real ones.”

Now read: Five steps to help you retire early and holiday for the rest of your life


Stockhead has not provided, endorsed or otherwise assumed responsibility for any financial product advice contained in this article.