Disadvantages of the Bucket Investing Method

Some investment advisors favor what’s called the “bucket method” of investing. Academic types call it “time segmentation.” Basically, in this method you divide the future into time periods and assign different amounts of money to each period. Money you need in the nearest time period is invested in liquid, conservative assets. Money that is needed in later periods can be invested in riskier, more aggressive assets. Each time period is sometimes referred to as a bucket.

This blog post refers to a series of articles by academic Wade Pfau that compares the bucket method to a total return investment method. The articles find fault with the bucket method but find instances when it can be fine-tuned to make assets last longer than the total return method. This post, written by a former fan of bucketing, says there are at least three flaws with the bucket method under even the most favorable assumptions and circumstances.

In standard bucketing, you put equities into the final bucket, the one that you tap last, or whose appreciation you occasionally take off the table and put into an earlier bucket. Equities certainly belong in a retirement portfolio, to protect against inflation or provide a bequest whose basis steps up. They satisfy a universal yen for upside; retirees don’t like to feel that they’re making a “dead-stick landing” to eternity.

But if a retiree wants to reduce longevity risk with the final bucket, equities don’t fill the bill. They carry market risk, which could potentially make longevity risk worse instead of making it go away. Pfau observes that people who have not saved enough may want to hold equities as a long-term catch-up strategy. That’s risky. Banks don’t hold equities as their reserves; why should retirees hold equities as their reserves?