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 portfolios. 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, meaning does it meet a retiree's cash needs while also generating a satisfactory level of return?
I began creating sample bucket retirement portfolios--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 positioned 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 Inflation-Protected Securities in portfolio holding Harbor Real Return
, appear to have limited upside potential today.
The Starting Portfolio
The starting portfolio, featured in depth in this article
, is geared toward young retirees with an anticipated time horizon of 25 years. They will use a 4% withdrawal rate, with an annual inflation 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.
Bucket 1: $120,000
$120,000: Cash (In my original portfolio, I used cash plus PIMCO Enhanced Short Maturity ETF
for bucket 1. But because the PIMCO fund has only been around since late 2009, I used Vanguard Prime Money Market as a proxy in the return simulation.)
Bucket 2: $480,000
$130,000: T. Rowe Price Short-Term Bond
$150,000: Harbor Bond
$100,000: Harbor Real Return
$100,000: Vanguard Wellesley Income
Bucket 3: $900,000
$400,000: Vanguard Dividend Growth
$200,000: Harbor International
$100,000: Vanguard Total Stock Market Index
$125,000: Loomis Sayles Bond
$75,000: Harbor Commodity Real Return
(Note that this fund wasn't launched until 2008, so I've used near-clone PIMCO Commodity Real Return
in its place in the return simulation.)
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.
For the purpose of back-testing our sample portfolio's returns, we used the following system:
- Reinvest all dividends and capital gains.
- Rebalance positions at the end of the calendar year if the position size exceeds 110% of its starting value in 2007.
- Use rebalancing proceeds from appreciated positions to meet living expenses.
- If rebalancing proceeds are insufficient to meet living expenses, withdraw cash from bucket 1 to meet planned living expenses.
- If rebalancing proceeds exceed living-expense needs, use to refill bucket 1 if lower than starting level ($120,000).
- If rebalancing proceeds meet living expenses and bucket 1 is full, use rebalancing proceeds to add to positions that have declined the most (or appreciated the least) since 2007.