How a widely accepted retirement strategy may create the illusion of safety while quietly increasing failure risk.

For years, risk bucketing has been one of the most widely accepted frameworks in retirement income planning.

The idea is simple. A retiree’s portfolio is divided into time-based buckets:

• A cash bucket for near-term income
• A medium-term bucket with lower-risk assets
• A long-term growth bucket invested in equities

When markets decline, income is drawn from the cash bucket instead of selling growth assets at depressed prices. In theory, this protects the portfolio from sequence-of-returns risk. It is a concept that feels both logical and comforting.

For a long time, I believed in it. I was trained in it, implemented it, and explained it to clients.

Then I encountered the modelling.

When Intuition Meets Evidence

Long-term historical simulations tell a different story.

Research examining 30-year rolling retirement periods shows that cash reserve strategies do not improve the sustainability of retirement income. In many cases, they increase the probability of portfolio failure.

The reason is simple: the income bucket introduces a permanent cash drag on the portfolio.

Because cash historically earns far less than diversified portfolios, maintaining large cash reserves reduces long-term returns. Over time this weakens the very engine that sustains retirement income.

The Illusion of Protection

The appeal of risk bucketing is largely psychological.

During market declines, retirees feel reassured knowing they are drawing income from cash rather than selling growth assets. Emotionally, this feels defensive.

But economically the portfolio behaves much like a traditional balanced portfolio that simply sells assets for income, except that the bucket strategy locks part of the portfolio into low-return assets for extended periods.

Research by Walter Woerheide and David Nanigian in Sustainable Withdrawal Rates: The Historical Evidence on Buffer Zone Strategies found that buffer-zone strategies do not improve sustainable withdrawal rates and can reduce portfolio longevity.

In other words, the protection many investors believe they are receiving may largely be an illusion.

The Market Timing Problem

Bucket strategies also assume that investors can avoid selling assets during bad markets.

But eventually the cash bucket must be replenished. If markets have not yet recovered, the strategy ends up selling assets at low prices anyway. As retirement researcher Michael Kitces notes, cash reserve strategies only improve outcomes if the investor happens to be a good market timer, a skill few possess consistently.

The Cost of Complexity

Risk bucketing also introduces operational complexity for advisors:

• Monitoring multiple buckets
• Replenishing income reserves
• Rebalancing between growth and income segments

If the strategy does not improve withdrawal sustainability, the added complexity becomes difficult to justify. In some cases, the structure may actually reduce the client’s probability of long-term success.

Behaviour vs. Optimization

To be fair, bucket strategies do have one real benefit: behaviour.

Knowing that several years of spending are held in cash can reduce anxiety during market downturns and help retirees stay invested.

But that benefit is psychological, not financial.

When Comfort Conflicts With Math

Retirement planning sits at the intersection of mathematics and human behaviour.

Risk bucketing feels safer because it separates short-term spending from long-term investments. Yet the historical evidence suggests that the cost of maintaining that separation can outweigh the benefits.

The uncomfortable reality is that the strategy designed to reduce perceived risk may actually increase the probability of running out of money.

Which raises an important question for advisors:

Are we designing portfolios to feel safer — or to be safer?

 

Written by Marius Kilian

 

Sources

* “Sustainable Withdrawal Rates: The Historical Evidence on Buffer Zone Strategies”, W. Woerheide and D Nanigian, Journal of Financial Planning, May 2022

* “Research Reveals Cash Reserve Strategies Don’t Work… Unless You’re A Good Market Timer?”,  M.Kitces, Kitces.com, Mar 2017