A while back, I was speaking with a fellow who had recently retired. He shared this observation, only half-jokingly: “Working was easy,” he said. What he meant was that financial management during our working years is more straightforward than it is in retirement. When we’re working, we earn and save and hope that our savings grow. But when we get to retirement, it becomes more complicated to know exactly how to manage those savings.

In the 1950s, a Ph.D. student named Harry Markowitz developed a framework to help investors answer this question. His approach, which is now known as modern portfolio theory, provided new insights on how to effectively diversify a portfolio. He later won a Nobel Prize for this work. But useful as it was, modern portfolio theory involved a lot of math and didn’t offer investors any practical help in managing their savings. Other academic theories have emerged over the years, but all of them involved similar levels of complexity.

It was for that reason that in 1985, financial planner Harold Evensky developed an idea that’s now known as the “bucket strategy.” The idea is that investors—especially those in retirement—should segment their portfolios. To understand this idea, we can look at a simple example.

Suppose Tom is a recent retiree and planning to withdraw 5% of his portfolio each year for the next several years. To protect against a potential stock market downturn, it would be reasonable for him to hold five years worth of withdrawals in some combination of cash and short-term bonds, since that corresponds, more or less, to the length of the worst stock market downturns we’ve seen in modern times.

In Evensky’s model, cash and bonds would be the first bucket, and the math is straightforward: If Tom wants to withdraw 5% each year and wants to set aside enough for five years, then he’d hold 25% (that is, 5% x 5) in the first bucket. With that 25% allocated to bonds for stability, Tom could then feel free to allocate the remaining 75% to stocks.

The benefit of this structure is that Tom would then have the flexibility to withdraw from either the stock or bond side of his portfolio depending on where the stock market stood in any given year. Most importantly, by putting a wall between his stocks and his bonds, Tom would be able to avoid selling stocks during market downturns.

The bucket concept can be very useful, but it’s important to know that there isn’t just one bucket strategy. Since Evensky first introduced the idea 40 years ago, a handful of alternatives have evolved.

Evensky’s original structure consisted of just two buckets. This makes it simple and easy to manage. A downside, though, is that bonds can still lose money, so neither of the two buckets could be considered truly safe. In 2022, in fact, total-bond market funds lost more than 10% of their value, and it took several years for investors to get back to even.

Thus, one of the most popular ways to structure a bucket portfolio is to add a third bucket, for cash. To be sure, cash doesn’t offer much growth potential. But it would’ve been extremely helpful in a year like 2022, when both bonds and stocks lost money.

While it provides more protection, the downside of a three-bucket approach is that it’s more complicated and somewhat harder to manage. Proponents, however, argue that it doesn’t require much more effort than traditional portfolio rebalancing and is well worth the effort.

In his book, The Aspirational Investor, Ashvin Chhabra lays out another bucket alternative. Chhabra is less concerned with the distinction between bonds and cash. Instead, he advises investors to focus on the riskier side of their portfolios. He suggests that investors distinguish between standard, publicly-traded stock market investments and any alternative assets, such as private funds and real estate, that they might hold. Chhabra feels this segmentation is important because of the nature of alternative investments. They’re a little like lottery tickets: They can turn into home runs but can also go to zero.

If you’re constructing a portfolio and like the idea of a bucket approach, which way should you go?

Since each of these approaches has merit, you could combine them all, creating a four-bucket setup, consisting of cash, bonds, stocks and alternatives. That wouldn’t be unreasonable, but it would also ratchet up the complexity level.

Here’s the approach I recommend: First, like Chhabra, I would draw a distinction between traditional assets and alternatives. Traditional, publicly-traded investments, including standard stock and bond mutual funds and ETFs, would go in your core portfolio. These are the assets around which you’d build your plan.

Alternatives, if you own them, would go in their own separate bucket. In general, I don’t recommend these types of assets because their performance is more variable and more unpredictable, and because they tend to carry higher fees. But if you already own some alternatives, I’d separate them from your financial plan and view them only as a bonus if they deliver value. In other words, make sure that your financial plan will still work if you were to rely on only your core portfolio.

Within the core, I’d have just two buckets: one for stocks and one for bonds. The result is that you would have just two buckets, plus alternatives, if you happen to own them.

But what about cash, since, as we saw earlier, bonds aren’t guaranteed and can certainly lose money? In my view, a dedicated, separate cash bucket isn’t necessary. Instead, what I recommend is to be diligent in diversifying your bond holdings. I wouldn’t own a total-bond market fund. Instead, take a building block approach, holding some short-term and some intermediate-term bond funds. Short-term funds will shine when rates are rising because they’ll decline much less than total-bond market funds. Intermediate-term bonds, on the other hand, will shine when rates are dropping. You could also add some inflation-protected bonds to round out your holdings.

At the end of the day, the best portfolio structure is the one that’s simple to manage while also protecting your savings from whatever surprises the market delivers.

P.S. Last week, I joined Christine Benz and Amy Arnott on Morningstar’s The Long View podcast to talk about retirement planning, navigating market uncertainty, gold and other personal finance questions.