17
Morningstar FundInvestor
April 2
013
goal of this portfolio sleeve is to stabilize principal to
meet income needs not covered by other income
sources. To arrive at the amount of money to hold in
Bucket
1
, start by sketching out spending needs
on an annual basis. Subtract from that amount any
certain, nonportfolio sources of income such as
Social Security or pension payments. The amount left
over is the starting point for Bucket
1
. That’s the
amount of annual income Bucket
1
will need to supply.
Bucket 2:
Years 3–10
$130,0000:
T. Rowe Price Short-Term Bond
PRWBX
$150,000:
Harbor Bond
HABDX
$100,000:
Harbor Real Return
HARRX
$100,000:
Vanguard Wellesley Income
VWINX
This portion of the portfolio is next in line to supply
living expenses once Bucket
1
has been depleted.
The goal for Bucket
2
is stability and inflation protec-
tion as well as income and a modest amount of
capital growth. It’s anchored by two sturdy, flexible
core bond funds—one short-term and the other
intermediate. In addition, it includes exposure to infla-
tion-protected securities and a hybrid stock/bond
fund (Vanguard Wellesley Income) to provide income
with a shot of equity exposure. Note that with real
yields in negative territory, Treasury Inflation-Protected
Securities aren’t especially attractive now, so inves-
tors would do well to build their positions in the asset
class slowly over a period of years.
Income distributions from this portion of the portfolio
can be used to refill Bucket
1
as those assets are
depleted. Why not simply spend the income proceeds
directly and skip Bucket
1
altogether? Because most
retirees desire a reasonably consistent income stream
to help meet their income needs. If yields are low—
as they are now—the retiree can maintain a consis-
tent standard of living by looking to other portfolio
sources, such as rebalancing proceeds from Buckets
2
and
3
, to refill Bucket
1
.
Bucket 3:
Years 11–25
$400,000:
Vanguard Dividend Growth
VDIGX
$200,000:
Harbor International
HAINX
$100,000:
Vanguard Total Stock Market
Index
VTSAX
$125,000:
Loomis Sayles Bond
LSBRX
$75,000:
Harbor Commodity Real Return
HACMX
Because this component of the portfolio will remain
untouched for the next decade, the assets here are
primarily invested in equities, with smaller stakes in
high-risk bonds (Loomis Sayles Bond) and commodi-
ties for inflation protection. This portion of the portfolio
also includes a fairly high stake in foreign stocks,
which have the potential to add to the portfolio’s
volatility level in part because of currency fluctuations.
Risk-conscious investors might therefore consider
scaling back the foreign-stock portion of the portfolio.
Bucket Maintenance
The bucket structure calls for adding assets back to
Bucket
1
as the cash is spent down. Yet investors
can exercise a lot of leeway to determine the logistics
of that necessary bucket maintenance.
The following sequence will make sense in
many situations:
p
Income from cash holdings in Bucket
1
. These will
be of limited help in the current yield-starved
environment, but they could become more mean-
ingful if yields rise.
p
Income from bonds and dividend-paying stocks
from Buckets
2
and possibly even
3
. (Income-
focused investors might decide that their bucket
maintenance starts and stops with these
distributions.)
p
Rebalancing proceeds from Buckets
2
and
especially
3
.
p
Principal withdrawals from Bucket
2
, provided the
above methods have been exhausted. Such
a scenario would tend to be most likely in a
2008
-
style environment, when bond and dividend
yields dropped and equities slumped, thereby
making it an inopportune time to unload equities.
(Such a scenario would generally be a decent
time to engage in tax-loss selling, but the proceeds
from that would be best deployed back into
equities.)
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Contact Christine Benz at
