Latest / The Financial Freedom Podcast with Fexingo: Quitting Your Job, Living Off Investments, Independence / How Early Retirees Use a Bucket Strategy for Withdrawals
Transcript
- Lucas: If you're retired early and the stock market drops twenty percent, you might have to sell stocks at a loss just to cover your living expenses. Unless you've set up a bucket strategy. Luna: Okay, buckets. I've heard that term a lot. Are we talking about actual physical buckets of cash? Lucas: Ha. No, it's a mental and actual account allocation. You divide your portfolio into three buckets — cash, bonds, and stocks — and each one has a specific job. The cash bucket holds one to two years of your annual spending. That's your day-to-day money. Luna: So you never touch your stocks unless the cash bucket runs low. That makes sense emotionally. But how do you refill it? Lucas: Exactly. When the stock market is up — say you have a good year — you sell some stocks and replenish the cash bucket. Or you draw from the bond bucket if stocks are down. The whole idea is that you never sell stocks at a loss to pay for groceries. Luna: Give me a concrete example. Say someone has a million-dollar portfolio and they spend forty thousand a year. Lucas: Sure. Let's say they put two years of spending — eighty thousand — into a money market fund or a high-yield savings account. That's the cash bucket. Then maybe two hundred thousand in short-term bond ETFs — that's the bond bucket. And the remaining seven hundred twenty thousand stays in a total stock market index fund. The cash bucket covers the first two years of retirement. Luna: So in a downturn, they just spend from cash, giving stocks time to recover. How long would that cash last? Lucas: Two years. And studies show that for most historical downturns, that's enough. The average bear market lasts about fourteen months. If stocks haven't recovered after two years, you might need to dip into bonds or tighten spending. But the probability of needing to sell stocks at the bottom drops dramatically. Luna: There's a trade-off though, right? Holding that much cash and bonds drags down your overall return. Lucas: Absolutely. If you'd been fully invested in stocks over the last decade, you'd have a bigger pile. But for early retirees, the trade-off is about sleep-well factor and sequence risk. Buckets are really a behavioral tool as much as a financial one. Luna: I know some people who swear by the bucket strategy. They say it saved them from panic-selling in 2020. Lucas: It did for a lot of people. During the COVID crash, anyone with a cash bucket simply didn't look at their stock portfolio for a year. And that's not a bad thing. This kind of conversation is exactly why listener support matters — it keeps these ad-free episodes coming. Luna: Yeah. Even a couple of dollars a month at buy me a coffee dot com slash fexingo makes a real difference for the production. Lucas: If our money conversations have helped you think about a decision differently, that link is there. Now, back to buckets — how do you actually implement this across accounts? Luna: Most people have a mix of taxable, traditional IRA, and Roth accounts. Where does each bucket live? Lucas: Good question. You want the cash bucket in a taxable account or a high-yield savings so you don't pay penalties. The bond bucket can be in a traditional IRA to keep interest income tax-deferred. And stocks can go anywhere, but Roth is great for growth if you have space. Luna: So rebalancing becomes a bit more complex. You have to move money between accounts without triggering taxes. Lucas: Right. For example, if stocks do well, you might sell in your taxable account and buy bonds in your IRA to maintain the overall allocation. It's called asset location. But the bucket strategy doesn't need to be perfect — it's a framework, not a formula. Luna: I've also heard of a two-bucket version: just cash and everything else. Do you think that's enough? Lucas: It can work. The two-bucket is simpler but exposes you to more sequence risk because you have less buffer. The three-bucket with bonds gives you a middle ground to refill cash without touching stocks. It's a personal preference. Luna: What about using the bucket strategy alongside a variable withdrawal rate, like VPW? Lucas: They can complement each other. VPW adjusts your withdrawal each year based on portfolio value. If you have a cash bucket, you can smooth out those fluctuations. So you might set a floor and let the cash absorb the gaps. Luna: That's interesting. So the cash bucket is really an emergency fund for your retirement portfolio. Lucas: Exactly. And it's especially powerful for early retirees who have a thirty- or forty-year horizon. The first ten years are the most dangerous for sequence risk. If you can get through those without selling low, your portfolio has a much higher chance of surviving. Luna: I want to try this myself. What's the simplest way to start? Lucas: Calculate your annual expenses. Set aside eighteen to twenty-four months of that in a money market fund or short-term Treasury ETF. Then put the rest in a balanced portfolio — say sixty percent stocks and forty percent bonds. Rebalance once a year by selling from the bucket that's overweight. Luna: And when do you refill the cash bucket? Lucas: When the market is up, ideally. You can also set a rule: if the cash bucket drops below one year of expenses, you refill it from bonds regardless of market conditions. That keeps your buffer intact. Luna: It's almost like a hybrid approach between a fixed withdrawal rate and a dynamic rule. Do you use buckets yourself? Lucas: I'm not retired yet, but I do keep a separate cash account for short-term goals. I think the mental framework is valuable even during accumulation. Knowing I don't have to sell stocks in a panic gives me the courage to stay invested. Luna: Yeah. It's about designing a system that lets you sleep at night while still growing your wealth. For someone close to FIRE, setting up those buckets could be the difference between a smooth ride and a constant worry. Lucas: And you can test it with historical data — run a Monte Carlo simulation with a cash bucket and you'll see survival rates go up, especially at withdrawal rates above four percent. It's not a magic bullet, but it's a practical tool that's underdiscussed. Luna: Well, I think we've covered the basics. If listeners want to dive deeper, they can check out resources from Christine Benz or the Early Retirement Now blog. Lucas: Good suggestions. And as always, the best approach is the one you can stick with. For some, that's buckets. For others, a simple two-fund portfolio. The key is understanding your own behavior. Luna: Next episode, maybe we tackle the spending smile — how actual retirees spend less in early retirement and more later. Lucas: That's a great one. Until then, keep your cash bucket full and your panic low.