After decades of saving for retirement, the time comes for retirement. This transition should be simple, but more than half of all Americans worry about financial stability in retirement, according to MarketWatch.

A third of our clients have retired and lived off regular withdrawals from their portfolios. Once the client and our advisors calculate the cost of supporting their lifestyle in retirement, we set up a monthly draw from clients’ investment portfolios and deposit those funds into their checking accounts as a replacement paycheck.

Our clients can draw (conservatively 4%/year or 5% aggressively/year) from their portfolios and never run out of money under any scenarios short of a nuclear war, meteor strike, or worldwide zombie apocalypse. A family with a $2 million portfolio can withdraw $80,000 to $100,000 per year, with additional funds coming from Social Security and a pension if any.

In more than 25 years of running Heron Wealth, we have never once reduced a client’s monthly draw because of stock market volatility.

How is this possible?

Back in 2009, the stock market fell 55% in six months. In early 2020, the stock market fell 35% in three months. At least once every three years, the market falls 10%. Every five years or so, the market falls 20%.

Through all that volatility, we employ a straightforward solution to keep our retired clients’ draws stable and portfolios intact – the Three-Bucket Retirement Income Strategy.

Making It Work

When a client retires, we split their portfolio into three buckets: risk assets; fixed income; and near cash.

We invest the client’s assets such that the risk bucket represents 60% to 70% of their portfolio, invested in faster-growing but volatile U.S. and international equities. We reasonably project that bucket will grow on average 7% to 9% per year, but we also know that wide swings in either direction are possible.

Once or twice a year, we rebalance the risk bucket to target allocations and pour the excess cash into the fixed income bucket, which contains 25% to 35% of the overall portfolio. We invest those assets in government bonds and agency bonds, high-grade and high-yield corporate bonds, and preferred stock. We reasonably expect the fixed income bucket to grow 3% to 4% a year, with far less volatility compared to the risk bucket.

Rebalancing the fixed income bucket pours excess funds into the near-cash bucket, which invests in government securities with maturities of one year or less, commercial paper, and CDs. The near-cash bucket generates a negligible return of 0.5% to 1.5% per year, but with negligible volatility.

Each month, we distribute the client’s draw from the near-cash bucket.

What about bear market years like 2008-09, when U.S. stocks plummeted 55% in six months?

When stocks fall dramatically, we simply suspend the distributions from the risk bucket to the fixed income bucket, but we continue flowing funds from fixed income to near cash. We DON’T shift funds upstream to the risk bucket from fixed income and cash, nor do we aggressively liquidate equities to raise cash.

Why not?

We know from history that even in the worst circumstances, equity markets rarely take more than five years to recover to new highs.

The “Black Friday” market crash of September 1929 provides one exception in the past 100 years. The Dow Jones Industrial Average took 25 years to make a new high in 1954. Taking into account the high-dividend yields of the 1930s, however, which peaked at an average of 14%/year, an investor who bought stocks right before the crash would have recovered his or her entire investment by late 1936, seven years from the 1929 peak and 4.5 years off the market low of the summer of 1932.

Before the Great Recession of 2008-09, the S&P 500 peaked in October 2007 but made new highs by February 2013.

Stocks peaked in January 2020, fell 35% as the COVID-19 pandemic spread, but reached new highs in only six months.

There’s nothing magical about the Three-Bucket Retirement Income Strategy. Keeping a year of living expenses in the near-cash bucket, and four years of cash flow in the fixed-income bucket means that clients can outlast a five-year drought in equity returns.

Good advisors have promoted this strategy for decades. Successfully using the strategy requires only two commitments on the client’s part.

Set — and adhere to — pre-retirement savings goals. For the strategy to work, the client must amass a large-enough portfolio.

Live on a 4% to 5% annual draw. Exceeding 5% per year raises the odds of not having enough funds, net of the draw, to sustain future draws after a prolonged downturn in stocks.

David Edwards is president and wealth advisor with Heron Wealth, a $500 million registered investment advisor based in New York City working with 225 client families across the U.S. and around the world. Dustin Lowman contributed additional research for this column.