The second bucket can be invested in a combination of income and growth assets. How best to get income from investments in retirement is a problem that has many possible solutions.
The return on an investment portfolio is a combination of income (interest or dividends) and capital gain (the increase in the value of the investments over time).
The disadvantage of income-producing investments is that the income is taxable and in general they offer little or no capital gain and a low return.
The disadvantage of growth investments, which offer capital gain and higher returns over the long term, is volatility, and to get cash you may have to sell investments at a time when their value is down.
Running down investment capital is another issue. Some investors wish to leave a sizeable inheritance while others don't; some are wary of running down capital in the early stages in case large sums are required later.
The three-bucket approach to portfolio planning is a simple solution to these problems.
Divide your expected retirement into three periods; the first five years, the next 10 years beyond that, and your final years. Estimate your beginning retirement capital and how much you want to have left at the end in today's dollars. Next, decide how much you want to use up in each of the three periods.
These are your three buckets of money. Plan to invest the first bucket (for the first five years) in term deposits or bonds and to use up both the income and capital over that period.
The third bucket, including final capital, will remain untouched for around 15 years and can be invested in growth assets.
The second bucket can be invested in a combination of income and growth assets which will be converted to income assets only when the first bucket is used up. This is a simple yet effective approach.
* Liz Koh is an authorised financial adviser. The advice given here is general and does not constitute specific advice to any person. A disclosure statement can be obtained free, call 0800 273 847. For free e-books see moneymax.co.nz and moneymaxcoach.com