16
Using buckets to organize your retirement portfolio
by time horizon has caught on because of the psycho-
logical benefits. By maintaining a dedicated cash
pool to draw upon for near-term living expenses—the
linchpin of every bucket program—retirees can ride
out fluctuations in the long-term portion of their port-
folios. They can also switch on automatic withdrawals
from their cash buckets to simulate a paycheck, and
that reliable income stream can provide comfort in
good markets and bad. Finally, a bucket strategy gets
retirees away from what I consider to be an unhealthy
form of mental accounting: focusing on income at the
expense of total return. But does bucketing actually
work in practice—does it meet a retiree’s cash needs
while also generating a satisfactory level of return?
I began creating sample bucket retirement portfo-
lios—consisting of both traditional mutual funds and
exchange-traded funds—just last year, so they don’t
have a sufficiently long track record to observe. But at
the risk of being accused of data-mining, I took a
look back at one of my bucket portfolios to see how it
would have performed during the stress test of the
2008
financial crisis and in the subsequent equity
market recovery. I tested the most aggressively posi-
tioned of the model bucket portfolios—the one
geared toward retirees with
25
-year time horizons.
That portfolio’s heavy equity weighting has been a
big help recently as stocks have rallied, but its equity-
heavy stance also left it with a big hole to claw its
way out of in
2008
.
The exercise yielded some encouraging results during
this admittedly arbitrary time period. The headline
is that at the end of
2012
, the value of the aggressive
bucket portfolio was ahead of the starting value of
the portfolio, even though our fictitious retiree was
also withdrawing
4%
of the portfolio, adjusted for
inflation, per year. Of course, there’s no guarantee
that a bucket portfolio started today will fare as well,
particularly given rock-bottom bond yields and the
fact that equity market valuations are nowhere near
as attractive as they were following the
2008
market
crash. Specific categories, such as the Treasury Infla-
tion-Protected Securities in portfolio holding
Harbor
Real Return
HARRX
, appear to have limited upside
potential today.
The Starting Portfolio
The starting portfolio is geared toward young retirees
with an anticipated time horizon of
25
years. They
will use a
4%
withdrawal rate, with an annual infla-
tion adjustment, which translates into a $
60
,
000
withdrawal from their $
1
.
5
million portfolio in the first
year of retirement. They have a high risk tolerance.
The sample portfolio features the following holdings
in the following dollar amounts.
Cash Flow and Rebalancing Rules
One of the keys to making a bucketing strategy work
is to have a plan for bucket maintenance: how you’ll
refill bucket
1
if it becomes depleted and how you’ll
manage rebalancing.
Testing the Bucket Approach to
Retirement
Portfolio Matters
|
Christine Benz
Welcome to our
new feature,
Portfolio Matters,
by Christine Benz,
Morningstar’s director of
personal finance. We’re
thrilled to have Christine
help you manage the port-
folio challenges that you
face each month. Christine
will address personal
finance issues with prac-
tical solutions throughout
the year.
Bucket 1: $120,000
$120,000
Cash
(In my original portfolio, I used cash plus
PIMCO
Enhanced Short Maturity ETF
MINT for bucket 1.
But because the PIMCO fund has only been around
since late 2009, I used
Vanguard Prime Money
Market
VMMXX as a proxy in the return simulation.)
Bucket 2: $480,000
$130,000
T. Rowe Price Short-Term Bond PRWBX
$150,000
Harbor Bond HABDX
$100,000
Harbor Real Return HARRX
$100,000
Vanguard Wellesley Income VWINX
Bucket 3: $900,000
$400,000
Vanguard Dividend Growth VDIGX
$200,000
Harbor International HAINX
$100,000
Vanguard Total Stock Market Index VTSMX
$125,000
Loomis Sayles Bond LSBDX
$75,000
Harbor Commodity Real Return HACMX
(Note that this fund wasn’t launched until 2008, so
I’ve used near-clone PIMCO Commodity Real
Return PCRAX in its place in the return simulation.)
