The linchpin of any bucket framework is a highly liquid component to meet near-term living expenses for one year or more. When cash yields are close to zero, bucket 1 is close to dead money, but the goal of this portfolio sleeve is to stabilize 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 spending needs on an annual basis. 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: That's the amount of annual income bucket 1 will need to supply.
More conservative investors will want to multiply that figure by 2 or more to determine their cash holdings. Alternatively, investors concerned about the opportunity cost of so much cash might consider building a two-part liquidity pool--one year's worth of living expenses in true cash and one or more year's worth of living expenses in a slightly higher-yielding alternative holding, such as a short-term bond fund. A retiree might also consider including an emergency fund within bucket 1 to defray unanticipated expenses such as car repairs, additional health-care costs, and so on.
Bucket 2 and Beyond >>