16
Those who lived through the
1970
s and ‘
80
s no
doubt find their photographs from those decades
to be cringe-worthy. But while few may wish to
repeat a fashion era marked by pastel-colored suits
and big hair, one aspect of those bygone decades
is appealing—substantially higher interest rates than
those that prevail today. The average interest rate
on a six-month certificate of deposit was
9
.
1%
in
1970
and
13
.
4%
in
1980
. Of course, inflation was high
then, too, but those higher rates, plus the prevalence
of pensions, allowed many retirees to generate
livable income streams without invading their prin-
cipal or taking risks in stocks.
But two decades’ worth of declining interest rates
have dragged yields way down, dramatically
compounding the challenge for retirees. With infini-
tesimal yields on money market accounts and
high-quality bonds, retirees’ choices are stark: To be
able to afford retirement, they can plan to delay
the date, save more, reduce their standards of living,
or take more risks with their portfolios.
Here Comes the Bucket Brigade
The bucket approach to retirement-portfolio manage-
ment, pioneered by financial-planning guru Harold
Evensky, aims to meet those challenges, effectively
helping retirees create a paycheck from their invest-
ment assets. Whereas some retirees have stuck with
an income-centric approach but have been forced
into ever-riskier securities, the bucket concept is
anchored on the basic premise that assets needed to
fund near-term living expenses ought to remain
in cash, dinky yields and all. Assets that won’t be
needed for several years or more can be parked
in a diversified pool of long-term holdings, with the
cash buffer providing the peace of mind to ride out
periodic downturns in the long-term portfolio.
My construct includes a safe, liquid bucket for near-
term income needs; an intermediate-term bucket,
mainly bonds, that eventually will cover expenses
during the middle retirement years; and a long-term
bucket consisting mainly of stocks for the later
retirement years. Assets are periodically moved from
Buckets
2
and
3
into Bucket
1
to help meet income
needs. Note that income-producing stocks and bonds
are well-represented in my bucket portfolios. But if
the portfolio’s income level falls short of the retiree’s
target for living expenses, he or she can look to rebal-
ancing and tax-loss proceeds, capital gains distribu-
tions, and required minimum distributions to refill
Bucket
1
. The advantage of the total-return approach
is that it enables a retiree to build a better-diversified
portfolio—that is, one that should have more attrac-
tive long-term risk/reward characteristics—than one
anchored exclusively in high-income stocks and bonds.
Assumptions
To help illustrate what an actual bucketed portfolio
might look like, let’s assume we’re building a portfolio
for a soon-to-retire couple with the following attributes:
p
They have a $
1
.
5
million portfolio.
p
Their time horizon is
25
years, and they have a high
risk capacity.
p
They plan to withdraw
4%
of their initial balance in
year one of retirement ($
60
,
000
), then inflation
adjust that amount every year. They will also regu-
larly revisit their withdrawal rate, potentially
reducing withdrawals or at least forgoing the infla-
tion adjustment in weak market environments.
p
They have the desire to spend all of their money
during their lifetimes (that is, no desire to leave
a legacy).
p
They hold all of their assets within a tax-sheltered
account, so the aftertax withdrawal amount would
be lower than $
50
,
000
.
Bucket 1:
Years 1–2
$120
,
000
:
Cash (certificates of deposit, money market
accounts, and so on)
The linchpin of any bucket framework is a highly
liquid component to meet near-term living expenses
for one year or more. With cash yields close to zero
currently, Bucket
1
is close to dead money, but the
A Sample Retirement Portfolio
in Three Buckets
Portfolio Matters
|
Christine Benz
Welcome to our
new feature,
Portfolio Matters,
by Christine Benz, Morning-
star’s director of personal
finance. We’re thrilled to
have Christine help you
manage the portfolio chal-
lenges that you face each
month. Christine will
address personal finance
issues with practical solu-
tions throughout the year.
