The Bucket Approach to Building a Retirement Portfolio

Those who lived through the 1970s and 1980s no doubt find their photographs from those decades embarrassing. But while few may wish to repeat a fashion era marked by pastel suits and long hair, one aspect of those decades gone by is appealing: interest rates substantially higher than prevailing 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 back then, too, but those higher rates, plus the Predominance of pensions, allowed many retirees to generate decent income. streams of income without encroaching on your principal or taking stock risks.

But two decades of falling interest rates dragged yields down, sharply compounding the challenge for retirees. With low returns on money market accounts and high-quality bonds, retirees’ choices are tough: In order to afford retirement, they may plan to move the date back, save more, lower their standard of living, or take more risk with their portfolios. . .

The Bucket approach to retirement portfolio management, promoted by financial planning guru Harold Evensky, aims to meet those challenges, effectively helping retirees generate a paycheck from their investment assets. While some retirees have stuck to an income-focused approach but have been forced into increasingly riskier securities, the Bucket concept is based on the basic premise that the assets needed to finance living expenses short term they must remain in cash, minimum returns and everything else. . Assets that won’t be needed for several years or more can be parked in a diversified pool of long-term positions, and the cash reserve provides peace of mind to weather periodic downturns in the long-term portfolio.

The all-important bucket 1

the axis of any cube frame it is a highly liquid component to cover short-term living expenses for a year or more. The cash returns are extremely low, so Cube 1 is by no means a return mover. But the goal of this portfolio cover is to stabilize capital to meet income needs not covered by other sources of income. To arrive at the amount of money to keep in Bucket 1, start by outlining spending needs on an annual basis. Subtract from that amount any non-portfolio sources of income, such as Social Security or pension payments. The amount left over is the starting point for Bucket 1: that is the amount of annual revenue that Bucket 1 will need to supply.

The most conservative investors will want to multiply that figure by two to determine their cash holdings. Alternatively, investors concerned about the opportunity cost of so much cash could consider creating a two-part liquidity pool: one year of living expenses in actual cash and one or more years of living expenses in an alternative yield holding. slightly larger, such as a short-term bond fund. A retiree might also consider including an emergency fund within Bucket 1 to cover unforeseen expenses such as car repairs, additional health care costs, etc.

Cube 2 and beyond

Although retirees can customize different frameworks for the number of buckets they have and the types of assets in each, my Model Category Portfolios include two additional cubes, as follows.

Cube 2:Under my framework, this portfolio segment contains five or more years of living expenses, with the goal of generating income and stability. Therefore, it is dominated by high-quality fixed income exposure, although it could also include a small portion of high-quality dividend-paying stocks and other yield-rich securities, such as master limited partnerships. Balanced or conservative and moderate allocation funds would also be appropriate in this part of the portfolio.

Income distributions from this part of the portfolio can be used to fill Bucket 1 as those assets are depleted. Why not just spend the income directly and skip Bucket 1 altogether? Because most retirees want a reasonably steady stream of income to help meet their income needs. If returns are low, the retiree can maintain a constant standard of living by seeking other sources of portfolio, such as rebalancing income from Buckets 2 and 3, to refill Bucket 1.

Cube 3: The longer-term portion of the portfolio, Cube 3, is dominated by stocks and more volatile types of bonds, such as junk bonds. Because this part of the portfolio is likely to provide the best long-term performance, it will need to be trimmed periodically to prevent the total portfolio from becoming too stock-heavy. In the same way, this part of the portfolio will also have a much higher loss potential than segments 1 and 2. Those components of the portfolio are set up to prevent the investor from turning to segment 3 when in a recession, which in turn otherwise would convert paper losses into real ones.

Bucket Maintenance

The Bucket structure calls for assets to be added back to Bucket 1 as cash is spent. However, investors can exercise a lot of leeway in determining the logistics of that necessary Bucket Maintenance.

The following sequence will make sense in many situations:

1) Income from holding cash in Cube 1.

2) Income from bonds and dividend-paying stocks from Buckets 2 and possibly even 3. (Income-focused investors may decide that their bucket maintenance begins and ends with these distributions.)

3) Rebalance the income of Cubes 2 and especially 3.

4) Withdrawals of capital from Cube 2, provided that the previous methods have been exhausted. Such a scenario would tend to be more likely in a market environment like 2022, when bonds and stocks plunged at the same time, making it an inopportune time to unload stocks. (Such a scenario would generally be a decent time to participate in tax loss selling, but the proceeds from that would be better returned to the stock.)

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