We update the performance--and make one small adjustment--to our middle-of-the-road portfolio.
By Christine Benz | 02-20-14 | 06:00 AM | Email Article

The going has gotten tough for retiree finances during the past decade and a half, with extreme stock market volatility, incredible shrinking bond yields, and pensions under fire. Whereas the previous generation of retirees may have been able to easily generate a livable income with a combination of bond and dividend payments, doing so today is a heavier lift. The S&P 500 currently yields a little more than 2%, and high-quality intermediate-term bonds hardly pay much more than that. That means income-minded retirees need to either have a lot of wealth, such that the current 2.1% payout on a 60% stock/40% bond portfolio is enough to live on, or venture into higher-risk parts of the stock and bond markets to amp up their income streams. 

Christine Benz is Morningstar's director of personal finance and author of 30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances and the Morningstar Guide to Mutual Funds: 5-Star Strategies for Success. Follow Christine on Twitter: @christine_benz.

That challenging environment probably explains why the bucket concept for retirement-portfolio planning has gained so much traction during the past several years. Pioneered by financial-planning guru Harold Evensky, the bucket approach is simply a total-return portfolio combined with a cash component to meet near-term living expenses. The long-term portion of the portfolio includes income-producing securities, but its main goal is to maximize long-term total return. Proceeds from the long-term portfolio--whether from income, rebalancing, or both--are periodically plowed into bucket 1 to meet living expenses.

I began writing about bucket portfolios in late 2012, providing sample mutual fund and exchange-traded fund portfolios for investors with varying time horizons and risk preferences. In last week's article, I reviewed how the aggressive mutual fund portfolio had performed since its launch, and I recommended a few small tweaks to reduce its interest-rate sensitivity. This week, I'll assess how the moderate version of the portfolio has performed since its debut in late October 2012 and recommend one modest change.

Everything in Moderation
Whereas the aggressive portfolio is geared toward retirees with a 25-year (or longer) time horizon and an ability to withstand the volatility that comes along with a 50% equity weighting, the moderate portfolio assumes a 20-year time horizon and less of an appetite for short-term volatility. It holds a roughly 40% equity stake, with the remainder of the portfolio in bonds and cash; it also includes a 5% position in a commodities-tracking fund to help provide inflation protection. (Although inflation is under control at the moment, inflation's corrosive effect on long-term purchasing power is one of the natural enemies of retiree portfolios.)

In response to last week's article and portfolio, several readers noted that they were uncomfortable with that portfolio's hefty bond allocation, and that complaint will almost certainly arise in relation to this more bond-heavy portfolio, too. That's not an invalid criticism: Just as declining bond yields have helped bonds generate strong returns for nearly 30 years, a rising-interest-rate environment is likely to result in meager returns from the asset class in the coming decade, or decades. 

That said, I'd point out that the main goal of this and all of the bucket portfolios is to help the retiree generate adequate cash flow using a diversified total-return portfolio while also preserving principal; capital appreciation above and beyond what's needed for the retiree's living expenses during his lifetime is secondary. Retirees for whom increasing principal is a key aim may well want to run with a higher equity weighting, and the various buckets in these portfolios can be adjusted higher or lower to suit a retiree's own goals and risk preferences. Additionally, even though the portfolios include funds that have Morningstar Analyst Ratings of Bronze or better, investors should feel free to employ their own favorite like-minded holdings in lieu of the ones featured here. 

Moreover, I've taken steps to ensure that the portfolio won't experience undue volatility if and when interest rates trend up. The fixed-income portion of the portfolio emphasizes shorter-duration and more credit-sensitive bonds, and the core intermediate-term fund has a good deal of flexibility to range across bond market sectors and maintain an active duration stance. (Duration is a measure of interest-rate sensitivity.) 

I've included three buckets for the moderate portfolio--geared toward the near, intermediate, and long term.
Securities mentioned in this article



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Christine Benz does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.
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