17
Morningstar FundInvestor
September
2013
For the purpose of back-testing our sample portfolio’s
returns, we used the following system:
p
Reinvest all dividends and capital gains.
p
Rebalance positions at the end of the calendar
year if the position size exceeds
110%
of its starting
value in
2007
.
p
Use rebalancing proceeds from appreciated posi-
tions to meet living expenses.
p
If rebalancing proceeds are insufficient to meet
living expenses, withdraw cash from bucket
1
to
meet planned living expenses.
p
If rebalancing proceeds exceed living-expense
needs, use rebalancing proceeds to refill bucket
1
if
lower than starting level ($
120
,
000
).
p
If rebalancing proceeds meet living expenses and
bucket
1
is full, use rebalancing proceeds to add
to positions that have declined the most (or appreci-
ated the least) since
2007
.
The Stress Test: Year by Year
For a detailed look at the year-by-year results of our
bucket stress test, you can download a spreadsheet
on
mfi.morningstar.com
. I also included a synopsis of
the portfolio’s performance in each calendar year,
as well as the steps I took to maintain the portfolio.
Take-Away 1: Diversification Proves Its Mettle
Among the key conclusions from the exercise is that,
even more than the bucket framework, holding and
rebalancing a diversified portfolio in retirement can
help provide decent performance and deliver a steady
cash flow under a variety of market conditions. During
the depths of the bear market, for example, rebal-
ancing out of the portfolio’s appreciated stakes in
high-quality bonds helped meet planned withdrawal
amounts. Those rebalancing proceeds, plus cash
withdrawals from bucket
1
, obviated the need to with-
draw from equity assets while they were down. Main-
taining a sizable equity stake, meanwhile, allowed
the portfolio to rebound more than it would have if it
were focused strictly on bonds and other income-
producing assets, particularly as yields plummeted
coming out of the financial crisis.
Take-Away 2: Maintenance Strategy Matters
The back-testing of our bucket strategy also highlights
the role that bucket maintenance plays in the portfo-
lio’s performance and how many different variations
there are to consider. The maintenance strategy
featured here—which used rebalancing proceeds to
top up the portfolio’s cash stake before adding to
depressed positions—arguably reduced the portfolio’s
total-return potential in exchange for keeping cash
in the range of two years’ worth of living expenses.
(In essence, it values safety and peace of mind more
than growth potential.)
An investor who’s more interested in generating high
long-term total returns and less concerned about
safety and liquidity, on the other hand, might take the
opposite tack, plowing rebalancing proceeds into
depressed positions and then topping up the cash
stake. Alternatively, one might rebalance based on
percentage variations relative to asset-allocation
targets, rather than variations relative to initial posi-
tion sizes, as featured here. (Note that if a retiree
wishes to make his portfolio more conservative as it
is drawn down, the rebalancing strategy would
need to change to allow for larger cash and bond
components.)
Take-Away 3: More Complicated Than It Looks
Our model portfolio is less complicated than most
retirees’ situations, in that most people come into
retirement with multiple accounts, both taxable and
tax-sheltered; couples’ planning adds even more
wrinkles. That means real-life bucket setup and main-
tenance is going to be more complex than is the
case for the single portfolio featured here, owing to
asset-location and withdrawal-sequencing issues
and the need to take required minimum distributions
from tax-deferred accounts, among other consider-
ations. That shouldn’t deter you from employing buck-
ets in your own retirement distribution plan, but our
sample portfolio arguably oversimplifies what it takes
to implement such a system.
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Contact Christine Benz at
