Why Total Return is Better Than Buckets for Retirement Allocation
During your working years, investing can feel relatively straightforward: your primary goal is maximizing growth, and because retirement is far away, you don't have to worry about living off your portfolio. But as you approach retirement, you need to answer one of the most stressful questions in personal finance: How do I generate the income I need while minimizing the chance of running out of money before I die?
This is where your retirement portfolio allocation comes into play. At its core, a retirement allocation is the specific mix of investments (stocks, bonds, cash) that you choose to hold in order to generate a reliable income stream for the rest of your life.
To be successful, this retirement allocation needs to balance two competing risks:
Sequence-of-Returns Risk is the short-term danger of experiencing a severe stock market crash early in your retirement. If your portfolio is too risky, you could face a massive reduction in your portfolio balance, forcing you to sell stocks at rock-bottom prices just to pay your living expenses. This can permanently deplete your portfolio and cause you to run out of money much earlier than anticipated.
Inflation Risk is the long-term danger of rising living costs eroding your purchasing power. Over a 30-year retirement, if your portfolio is too safe, it won't grow fast enough to keep up with the cost of living, leaving you broke in your later years.
There are two common approaches to allocate your portfolio in order to address these dueling threats: the Bucket Strategy and the Total Return Strategy. On the surface, they seem like two completely different ways to approach retirement, but once we look at their underlying math, we’ll see that they often end up recommending similar retirement allocations.
That being said, just because they arrive at similar conclusions doesn’t mean they are the same, and indeed there are important reasons why the Total Return Strategy provides a more robust way of thinking about your retirement portfolio. First, we need to understand how both strategies work.
Approach 1: The Bucket Strategy
The Bucket Strategy (sometimes referred to as Time Segmentation or Liability Matching) involves segmenting your savings into different "buckets," each earmarked to cover your spending needs over a certain time period. A typical 3-bucket setup might look like this:
Bucket 1 covers your first 1-3 yrs of spending and is kept in very safe investments (high-yield savings accounts, money market funds, Treasury bills, CDs, etc) so that it is effectively immune to stock market crashes.
Bucket 2 covers the next 4-9 years of spending. It is kept in moderate growth and income investments such as intermediate-term bonds and treasuries.
Bucket 3 is for long-term spending needs (10+ years) and is invested for growth, ideally in a globally diversified portfolio of equities. Because the money isn’t needed for at least a decade, it can ride out any short-term market volatility.
Buckets 1 and 2 are essentially designed to mitigate sequence-of-return risk in the early years of retirement, while Bucket 3 is designed to mitigate inflation risk later in retirement. This segmentation of assets can be very reassuring: if the stock market crashes the day after you retire, you can simply look at Bucket 1 and say, "I have three years of cash sitting right here. I don't need to touch my stocks until the market recovers."
As your retirement progresses and Bucket 1 is spent down, you’ll need to decide if or when to replenish it. Some investors top off Bucket 1 by selling stocks from Bucket 3 (when markets are up or flat), continually preserving ten years of “safe” spending. In doing so, they are prioritizing protection from the shorter-term sequence-of-return risk over protection from the longer-term inflation risk.
Other investors spend down the safe buckets without replenishing them, intentionally depleting their cash and bonds. This approach acknowledges that sequence-of-return risk lessens over time (as the investor safely navigates early retirement without needing to sell stocks at a massive loss), and therefore the need for Buckets 1 and 2 decrease as well. This naturally allows their overall portfolio to become more stock-heavy later in life to combat long-term inflation.
Approach 2: The Total Return Strategy
In contrast to the Bucket approach, the Total Return Strategy treats your entire net worth as one giant, unified portfolio. You determine an overall allocation that balances your need for growth with your tolerance for risk—for example, 60% stocks and 40% bonds—and then adjust or rebalance that allocation over time as you progress through retirement. It typically involves these steps:
Establish an initial allocation: Assess your risk tolerance and perform some statistical modeling (such as Monte Carlo simulations) to identify a suitable balance of growth (stocks) and safety (bonds) that minimizes the probability of outliving your money.
Generate the income: Instead of pulling from a dedicated cash reserve, you sell whichever assets have outperformed each year (while being mindful of tax consequences). Because you are selling the more highly-appreciated assets, your withdrawals organically pull the portfolio back towards your planned allocation over time.
Rebalance or Adjust: Periodically execute trades to keep your portfolio aligned with your plan, either by rebalancing back to your initial allocation, or adjusting your allocation over time.
That last step requires a decision about how to adapt this strategy as your retirement progresses. Some investors rebalance back to their initial allocation, maintaining a stable buffer of bonds or cash to continually protect against sequence-of-return risk. This is analogous to refilling Bucket 1 in the Bucket Strategy, which similarly maintains a significant bond allocation.
Other investors adopt a dynamic allocation strategy by increasing their equity allocation over time, as the need to protect against sequence-of-return risk fades and the risk of inflation grows. This is sometimes referred to as a rising equity glidepath or bond tent, and accomplishes a similar result to spending down Buckets 1 and 2 in the Bucket Strategy.
Which Strategy Should I Use?
On the surface, it seems like the Bucket Strategy and the Total Return Strategy are completely different. With the Bucket Strategy, you are building an allocation from the ground up, based on your anticipated spending in each year of your retirement. With the Total Return Strategy, you are taking a more top-down approach, based on your overall risk tolerance and total-portfolio statistical modeling.
In practice, however, the two strategies often end up with similar results. Once we look at their underlying math, they often boil down to the same fundamental allocations. Essentially, they are two (very) different ways of accomplishing the same thing. To see this in action, let’s run the numbers for a typical retiree.
Step 1: Determining an Initial Allocation
Imagine two investors, Ann and Bill, that are nearing retirement. Both have a $1,000,000 portfolio and anticipate withdrawing $40,000 (4%) a year for living expenses. Ann opts to determine her retirement allocation using the Bucket Strategy, while Bill decides to take a Total Return approach. Here is how they might construct their starting portfolio allocations using their preferred strategies.
| Ann: The Bucket Strategy | Bill: The Total Return Strategy | |
|---|---|---|
| Goal | Ann plans to segment her $1M by spending timeline. | Bill plans to optimize his $1M for risk vs. return. |
| Steps | Ann multiplies her annual spending ($40k) by the number of years in each of her three buckets. | Bill uses historical modeling (like Monte Carlo analysis) to find a viable allocation that historically survives a 4% withdrawal rate. |
| Result | Bucket 1 (Yrs 1-3): 3 years of cash = $120k Bucket 2 (Yrs 4-9): 7 years of bonds = $280k Bucket 3 (Yrs 10+): Remainder in stocks = $600k |
The modeling results in a variety of allocations - ranging from an 80/20 stock/bond allocation down to a 50/50 allocation - that have a 95+% probability of success. Based on his risk tolerance, he selects a 60/40 allocation. |
| Underlying Allocation | Buckets 1 & 2 sum to $400k in fixed income assets, which means Ann’s overall allocation is 60% stocks / 40% fixed income. | Bill’s total portfolio approach directly produces an allocation of 60% stocks / 40% fixed income. |
Although they took very different routes to get there, both Ann and Bill ended up with the same 60/40 allocation at the start of their retirement.
Step 2: Rebalancing Back to Allocation
Let's fast-forward to the end of Year 1. Ann and Bill have both withdrawn $40k from their portfolios for their first-year living expenses. Let's assume it was a good year in the market, and their stocks grew by exactly $40k. This means that both of their portfolios are still worth $1M.
Ann assumes she now needs to refill her Bucket 1 since she has spent some of it. And Bill assumes he needs to rebalance his portfolio back to its initial allocation. Here is how that might happen:
| Ann: The Bucket Strategy | Bill: The Total Return Strategy | |
|---|---|---|
| Current State | Bucket 1: $80k in cash
Bucket 2: $280k in bonds Bucket 3: $640k in stocks Overall allocation: 64% stocks / 36% fixed income |
Stocks: $640k
Bonds: $360k Overall allocation: 64% stocks / 36% fixed income |
| Goal | Ann wants to keep her Bucket 1 full (3 yrs of cash) | Bill wants to maintain his carefully chosen retirement allocation. |
| Steps | Ann sells $40k of stocks from Bucket 3 and moves the proceeds to Bucket 1. | Bill sells $40k of stocks and uses the proceeds to purchase $40k of bonds |
| Result | Bucket 1: $120k
Bucket 2: $280k Bucket 3: $600k |
Stocks: $600k
Bonds: $400k |
| Underlying Allocation | Buckets 1 & 2 again sum to $400k in fixed income assets, returning Ann’s overall allocation is 60% stocks / 40% fixed income. | Bill’s rebalancing directly returns his overall allocation to 60% stocks / 40% fixed income. |
After one year of retirement, even though their methodology is completely different, Ann and Bill find themselves in the same place again. Psychologically, they are in two different worlds, but mathematically, their portfolios are effectively identical.
Note: Instead of withdrawing bonds to generate the $40k of income during the year, Bill could have instead sold his appreciated stocks, effectively accomplishing the rebalancing illustrated above in one step instead of two.
Step 3: Adjusting Allocations
In year 2, Ann does some reading about sequence-of-return risk and realizes that if she keeps refilling her cash bucket every year, she will unnecessarily end up protecting against sequence-of-return risk forever, while continually increasing her exposure to inflation risk. Moving forward, she decides to simply spend down her buckets without refilling them each year - not just in the years with bad returns, but every year, until the buckets are gone.
Bill also reads up in year 2 and comes to a similar realization: if he keeps rebalancing back to his initial 60/40 allocation each year, he will be overly protected against sequence-of-return risk and increasingly exposed to inflation risk. Moving forward, he decides to adjust his target allocation each year to incorporate more stocks and less bonds.
Bill knows that the danger zone for sequence-of-return risk is the first ten years of retirement, after which he would like to be at the more growth-oriented allocation of 90% stocks / 10% bonds. To get from his current 60/40 allocation to his final 90/10 allocation over ten years, he will need to increase his equity allocation by 3% per year. This means that at the end of year 2, he should rebalance to 63/37, then 66/34 the year after that, and so forth.
Let's fast-forward again, this time to year 5. The markets saw a mix of strong stock returns with some minor slumps in the intervening years. Ann and Bill have both withdrawn $40k from their portfolios each year for living expenses, Ann from her Buckets 1 and 2, and Bill from whichever assets have appreciated the most that year. Bill also rebalances each year, not to his initial retirement allocation but to his rising equity allocation for that year. Here is how that looks in year 5:
| Ann: The Bucket Strategy | Bill: The Total Return Strategy | |
|---|---|---|
| Current State | Bucket 1: $0 in cash
Bucket 2: $273k in bonds Bucket 3: $674k in stocks (Overall allocation: 71/29) |
Stocks: $666k
Bonds: $294k Overall allocation: 69/31 |
| Goal | Ann wants to continue spending down her safe buckets. | Bill wants to continue shifting his equity allocation upwards, this year to 75/25. |
| Steps | Ann withdraws another $40k from Bucket 2 (and does not replenish it from Bucket 3). | To get to his target allocation, Bill sells $64k in bonds, $40k of which is withdrawn for living expenses, while the remaining $24k is used to purchase more stock. |
| Result | Bucket 1: $0 in cash
Bucket 2: $233k in bonds Bucket 3: $674k in stocks |
Stocks: $690k
Bonds: $230k |
| Underlying Allocation | Ann’s overall allocation after her withdrawal is 74% stocks / 26% fixed income. | Bill’s adjustments shift his overall allocation to 75% stocks / 25% fixed income. |
While their allocations are not exactly the same each year, both Ann’s and Bill’s portfolios become increasingly tilted towards equities over time. Their reasoning is different - Ann is “spending down her safe buckets” while Bill is “increasing his equity allocation” - but the outcome is effectively the same. Both are successfully navigating the retirement danger zone where sequence-of-returns risk looms large, and are slowly shifting their portfolios to address inflation risk.
If They Result in Similar Allocations, Why is Total Return Preferable?
The main benefit of Bucket Strategy is that it can feel more intuitive and reassuring, allowing nervous investors to take comfort in their “safe” buckets, knowing that they are immune to market crashes. This confidence can help them weather turbulent markets without panic selling, a critical requirement of any retirement allocation.
That being said, the Total Return Strategy is often considered a more robust and statistically sound allocation strategy, offering several distinct advantages over the Bucket Strategy:
Long-term Focus: The Bucket Strategy gets asset allocation backward by letting short-term cash flow needs dictate the long-term portfolio (e.g., "I need three years of cash, therefore my portfolio should be 10% cash"). It is focused on questions like: "Where is my cash coming from for the next 3 years?" In contrast, the Total Return Strategy is focused on the most important question in retirement: "Will I run out of money before I die?" It seeks to optimize the portfolio to last as long as possible, and to outlast the retiree.
Safe Withdrawal Rate: The Bucket Strategy assumes you already know how much you can reasonably spend in retirement, and simply allocates your portfolio based on that withdrawal rate. Unfortunately, it is silent on whether that withdrawal rate is sustainable or not. In contrast, the Total Return Strategy utilizes probabilistic tools like Monte Carlo simulations to mathematically validate how much you can safely spend over the course of your retirement.
Growth Oriented: The Bucket Strategy can sometimes encourage retirees to be too conservative. Anxious bucket investors are often tempted to pad their safe buckets for peace of mind, which can easily result in an overly conservative portfolio (especially for average-sized nest eggs). While this feels safe today, it can result in significant "cash drag" that stunts long-term performance, increasing inflation risk and the danger of prematurely depleting assets. In contrast, the Total Return strategy optimizes the portfolio allocation for long-term growth, preventing the portfolio from holding too much cash.
Systematic Rebalancing: The Total Return Strategy encourages systematic rebalancing. If stocks crash, it recommends that you sell “safe” bonds to buy cheap stocks—forcing you to "buy low." Bucket strategies, conversely, are primarily driven by cash flow needs. During a crash, bucket investors play defense (living off cash) but rarely play offense (buying cheap stocks). In doing so, they forfeit the "rebalancing premium" and miss out on opportunities to buy undervalued assets to accelerate recovery from down markets.
Avoids Market Timing: While the Bucket Strategy clearly dictates spending from safe buckets during a down market, it is notoriously vague on refilling. If the market drops 12%, is that a "crash" where you stop refilling, or just a routine correction? When the market rebounds, at what exact point do you harvest gains? This ambiguity introduces subjective, emotional market-timing back into the investor's life. In contrast, the Total Return Strategy relies on objective rebalancing targets that remove any emotional guesswork.
Asset Location: Viewing your portfolio as a single, holistic pie makes it much easier to optimize for taxes. For example, it allows you to place tax-inefficient bonds in traditional IRAs, or high-growth stocks in tax-free Roth IRAs. Bucket strategies can sometimes complicate this, particularly when the buckets are implemented at the account level. Because these investors try to isolate specific assets in separate physical accounts, they often accept sub-optimal tax placement.
So, while the underlying allocations from both strategies are often similar, the long-term focus and analytical rigor of the Total Return Strategy is more likely to result in an allocation that minimizes the risk of the retiree outliving their portfolio.
In practice, since both strategies often result in similar allocations, they can be used in conjunction to help reassure the investor that they are on the right track. If an investor arrives at a 70/30 retirement allocation using the Total Return strategy, they may find it helpful to consider their 30% bond allocation as a safety bucket of sorts, providing a certain number of years of protected cash flow.
At the end of the day, no matter what strategy you use, it's important that your allocation gives you the confidence and peace of mind that your portfolio will support your needs throughout your retirement.
