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When it comes to creating a bond portfolio, most investors focus on what to purchase. The 3-bucket approach is a much better question because it involves first asking yourself when you will need this money. In this article, we will discuss what it is, why the 3-bucket framework is important, what to put in each bucket, how to structure your portfolio, and the most common pitfalls that investors must avoid when creating a fixed-income portfolio.
What Is the 3-Bucket Bond Portfolio Strategy?
The 3-bucket strategy is a portfolio construction method based on one simple principle: Different goals require different instruments, and the bond that is used to finance a goal should be the one that matches the timeline of a goal.
It works by dividing your fixed income investments into three distinct buckets, each mapped to a time horizon:
- Bucket 1 — Short-term (0–2 years): Capital preservation and liquidity for near-term needs
- Bucket 2 — Medium-term (2–5 years): Balanced growth for planned future expenses
- Bucket 3—Long-term (5+ years): Maximising yield over time for wealth creation and retirement
The logic is simple but powerful. A bond that perfectly suits a 10-year goal — say, a long-dated G-Sec — is entirely inappropriate for money you may need in six months. Conversely, parking long-term wealth in liquid funds is a slow, silent wealth destroyer once inflation is accounted for. The 3-bucket strategy prevents both mistakes simultaneously.
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Why Does Maturity Matching Matter in Bond Investing?
Before filling the buckets, it helps to understand why maturity matching matters so deeply in fixed income.
Interest rate risk grows with maturity.
A 91-day T-Bill barely moves in price when rates change. A 30-year G-Sec can lose 20–25% (estimated figure) of its market value in a rising-rate environment. The longer the bond, the more its price responds to rate movements — and the more damage a mistimed purchase can do.
Reinvestment risk grows with shorter maturities.
Short-term bonds expire quickly, requiring you to reinvest consistently. When rates are falling, each reinvestment is at a lower yield—a gradual decline in returns that long-term bonds avoid by holding onto today’s rates.
Liquidity needs are not uniform.
Emergency funds and near-term goals must sit in instruments that can be accessed quickly without loss. Long-term goals can afford illiquidity in exchange for higher yield.
Matching the maturity of a bond to the timeline of a goal addresses all three of these risks simultaneously—which is why institutional investors have practiced this discipline, called Asset-Liability Management, for decades.
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Which Bonds Go in Each Bucket? An Extensive Guide for Indian Investors
| Bucket | Time Horizon | Instruments | Priority |
| Bucket 1 | 0-2 years | T-Bills, liquid/ultra-short funds, short-maturity AAA corporate bonds, short FDs | Capital safety and liquidity |
| Bucket 2 | 2-5 years | Dated G-Secs, SDLs, AA–AAA corporate bonds, BHARAT Bond ETFs, target maturity funds | Balance of yield and safety |
| Bucket 3 | 5+ years | Long-dated G-Secs (10–40 yr), SGBs, NHAI/PFC/REC bonds, 54EC bonds, high-yield corporate bonds | Maximum yield over time |
A few instruments deserve particular mention in the Indian context. BHARAT Bond ETFs—target maturity funds that invest in AAA-rated PSU bonds—are one of the cleanest Bucket 2 instruments are available to retail investors: defined maturity, known yield, tax efficiency, and exchange listing. 54EC bonds from PFC and REC are natural Bucket 3 instruments for investors managing capital gains from property sales. And SGBs, with their 8-year maturity and gold price upside, occupy a unique space at the longer end of Bucket 3.
How to Allocate Across the 3 Buckets
There’s no one-size-fits-all allocation — the right mix depends on age, income stability, existing liabilities, and risk appetite. But a practical framework to start with for a middle-aged salaried investor looks like this:
- Bucket 1: 20–25% — enough to cover 12-18 months of expenses and near-term planned goals
- Bucket 2: 35–40% — the engine of steady, predictable income over the medium term
- Bucket 3: 35–40% — the long-term compounder, calibrated to risk appetite
Younger investors with stable incomes and no imminent large expenses can tilt Bucket 3 more — say 50% — since time is on their side. Retirees or those close to a major goal should lean more heavily toward Buckets 1 and 2 to protect capital and assure liquidity.
When and How to Rebalance Your 3-Bucket Bond Portfolio
The 3-bucket framework is not a one-time allocation. It’s a living structure that requires periodic attention.
Over time, Bucket 3 investments will naturally migrate into Bucket 2 as their remaining maturity shortens—a 7-year bond bought three years ago is now a 4-year bond and belongs in Bucket 2. Likewise, Bucket 2 investments graduate into Bucket 1 as they approach maturity. The investor’s job is to periodically replenish Bucket 3 with new long-term investments, keeping the structure intact.
This rolling, self-replenishing logic is what makes the strategy sustainable over decades — and what distinguishes a managed bond portfolio from a collection of random fixed-income purchases.
3-Bucket Bond Strategy: Common Mistakes Indian Investors Must Avoid
Even investors who understand the framework make avoidable errors:
- Overcrowding Bucket 1—holding too much in short-term instruments feels safe but quietly destroys wealth once inflation is factored in over a 10-year horizon
- Ignoring credit quality within buckets—a high-yield bond does not belong in Bucket 1 simply because it matures in 18 months; credit risk and maturity risk are separate dimensions
- Never rebalancing—a bond portfolio left untouched drifts out of alignment as maturities shorten and goals change
- Chasing yield in Bucket 3 without liquidity cover—building a high-yield Bucket 3 is fine only if Buckets 1 and 2 are adequately funded first
- Treating all bonds as interchangeable—maturity, credit rating, yield, liquidity, and tax treatment all vary; each dimension matters independently
Who Should Use the 3-Bucket Bond Strategy?
The 3-bucket framework is not an advanced technique reserved for sophisticated investors. It is a common-sense structure that works for almost anyone building a fixed-income portfolio—from a first-time bond investor trying to make sense of the options available on an OBPP to a seasoned investor managing a multi-crore debt portfolio.
It is particularly well-suited to investors approaching or in retirement—where the sequencing of withdrawals matters as much as total returns—and to those with multiple financial goals at different time horizons running simultaneously.
3-Bucket Bond Portfolio Frequently Asked Questions
The 3-bucket strategy is a strategy for splitting a bond portfolio into three categories—short-term (0-2 years), medium-term (2-5 years), and long-term (5+ years). Each bucket is equipped with instruments appropriate to the corresponding timeframe—for short-term capital safety, medium-term growth, and long-term wealth creation.
Typically, bucket 1 contains T-bills, liquid funds, and short-maturity AAA bonds. The Bucket 2 suits include G-Secs, SDLs, investment-grade corporate bonds, and BHARAT Bond ETFs. Bucket 3 includes long-dated G-Secs, SGBs, infrastructure bonds issued by PSUs such as NHAI and PFC, and select high-yield corporate bonds.
A review once or twice a year is generally sufficient for most retail investors. The key trigger for rebalancing is when a Bucket 3 investment’s remaining maturity has shortened enough to belong in Bucket 2—or when a major life event (job change, approaching retirement, or large planned expense) shifts your time horizon and liquidity needs.
Yes, it’s one of the easiest to understand investment frameworks for new investors because it begins with goals and timelines, not products. Instead of asking “which bond should I buy”, it asks “when do I need this money?” which is a question that can be answered by any investor of any experience level.
Absolutely. Liquid funds and ultra-short duration funds work well in Bucket 1; target maturity funds and short-duration gilt funds in Bucket 2; and long-duration gilt funds or dynamic bond funds in Bucket 3. For investors who prefer the fund route over direct bond purchases, the framework works just as effectively.
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