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By Christine Benz | 09-14-15 | 06:00 AM | Email Article

T. Rowe Price has been one of Morningstar's favorite fund shops for decades. Though a public company, the firm has managed to serve both of its constituencies well: its fund shareholders as well as owners of  T. Rowe equity. To do so, the firm has generally kept expenses reasonable, fielded a utilitarian lineup light on trendy, ripped-from-the-headlines funds, and held on to managers for much of their careers. Management changes have picked up recently, as discussed here, and some of them have been unexpected; shareholders in some funds have gotten socked with tax bills. Typically, however, this is a sober, responsible shop that uses patient, disciplined strategies to help shareholders reach their goals. 

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.

I'll provide two sets of model T. Rowe Price "bucket" portfolios: one series geared toward investors in tax-deferred accounts, such as IRAs, and another, tax-conscious series geared toward T. Rowe Price investors in taxable accounts. 

Because the firm's lineup is dominated by actively managed funds, putting together T. Rowe Price portfolios doesn't have the same plug-and-play simplicity that all-index portfolios do. For example, one of Morningstar's longtime favorite T. Rowe funds,  Equity Income , is undergoing a manager change, with long-term skipper Brian Rogers set to step down in the fall. Moreover, some of the firm's best funds are closed to new investors, including  Mid-Cap Growth ,  Mid-Cap Value , and  Capital Appreciation . The firm's willingness to close funds is a positive for existing shareholders and has helped the firm maintain a steady A average Stewardship Grade since we began providing them. But it means that not all of the firm's best funds are available to new investors. Finally, some of our analysts' favorite T. Rowe equity funds skew toward the growth column of the Morningstar Style Box, albeit in a typically mild-mannered T. Rowe way. That presents a slight, but certainly not insurmountable, challenge for putting together well-balanced T. Rowe portfolios. 

Bucket Basics
There's no magic to a bucket strategy. At its heart is a total-return stock/bond portfolio, managed with an eye toward delivering both capital appreciation and income with a reasonable amount of risk. Alongside that longer-term portfolio, a retiree also holds a cash "bucket" consisting of one to two years' worth of living expenses. The idea behind the cash piece, as envisioned by financial-planning guru Harold Evensky, is that it provides a psychological buffer in turbulent times. Knowing that his or her living expenses are cordoned off, a retiree will be more inclined to stick with more volatile portfolio constituents with better growth and income prospects. The retiree can then periodically refill bucket one, as discussed here; income distributions can help refill bucket one, at least partially, and the retiree can then turn to rebalancing proceeds to supply the rest. 

As with all of the other portfolios, I used Morningstar's Lifetime Allocation Indexes as a starting point for these portfolios' asset allocations, and I turned to a list of Morningstar Medalist funds to help populate them. (You can use the left-hand screening feature to whittle down the universe--for example, you can screen by asset class and fund family.) I couldn't use medalists in every case, however. For example, I want Treasury Inflation-Protected Securities exposure in these portfolios (especially because they're tax-deferred and TIPS are tax-inefficient), but the firm's inflation-protected bond fund is not under coverage. Similarly, I used  T. Rowe Short-Term Bond even though the fund currently earns a Neutral rating. I wanted short-term bond exposure, and while the fund may not be on our list of favorites, nor is its performance likely to have a meaningful negative divergence relative to its peers. 

As with all of my other model portfolios, the goal of this one isn't to beat the pants off of other retirement strategies but rather to illustrate sound asset-allocation and portfolio-management concepts. Because I'm not a believer in tactical asset allocation, the portfolios will be managed with a strategic mindset--that is, buy, hold, and rebalance. I'll recommend changes only if our analysts have flagged a meaningful negative development at one of our holdings; my hope is there won't be many of those. Because I'm assuming they'll be held in a tax-sheltered account, the portfolios are managed without concern for tax efficiency; thus, they hold tax-unfriendly assets like TIPS and high-yield bonds. (Tax-efficient T. Rowe Price bucket portfolios are coming next week.)

Aggressive Bucket Portfolio
Anticipated Time Horizon: 25 or more years 

Bucket 1: Years 1-2
8%: Cash (money market funds and accounts, CDs, checking and savings accounts, and so forth; specific percentages will vary based on the amount of assets and the retiree's spending rate) 

Because the money in bucket one will be used for near-term spending needs, safety is the name of the game; we're sticking with cash. Note that the percentage allocation in bucket one/cash is an approximation; retirees should be sure to customize this amount based on their own anticipated spending needs. For example, a retiree who expects to spend $30,000 of her $1 million portfolio annually would hold $60,000 (6%) of her portfolio in bucket one ($30,000 times two). 

Bucket 2: Years 3-10
10%: T. Rowe Price Short-Term Bond
7%: T. Rowe Price Inflation-Protected Bond
15%:  T. Rowe Price New Income  

Bucket two steps out a bit on the risk spectrum. T. Rowe Price Short-Term Bond is in place to serve as next-line reserves in case bucket one is depleted and income and/or rebalancing proceeds from buckets two and three are insufficient to refill it. The fund was downgraded to Neutral from Silver earlier this year, an outgrowth of concerns over management changes, as well as the fact that unhedged currency exposures and a focus on corporate bonds could bring the fund extra risk relative to its peers. Nonetheless, the range of returns in the short-term bond category is generally modest; even though the fund isn't a cinch to outperform, it's unlikely to underperform by a wide margin. Silver-rated T. Rowe Price New Income serves as a fine core fixed-income holding; senior analyst Cara Esser notes that it "packs a bit more punch" than the Barclays U.S. Aggregate Bond Index but also keeps an eye on the downside, keeping duration within 20% of the index's and limiting exposure to lower-quality bonds. T. Rowe Price Inflation-Protected Bond is a fairly plain-vanilla TIPS fund; its performance has been respectable, and its fees are low. 

Bucket 3: Years 11 and Beyond
25%:  T. Rowe Price Dividend Growth
10%:  T. Rowe Price Equity Index
5%:  T. Rowe Price Diversified Small Cap Growth
5%: T. Rowe Price Real Assets
10%: T. Rowe Price Overseas Stock
5%: T. Rowe Price International Discovery  

Bucket three is the growth engine of the portfolio, so it's dominated by equity funds. The Silver-rated T. Rowe Price Dividend Growth, a large-blend fund, is the core equity position in the portfolio; like Vanguard Dividend Growth, it prioritizes high-quality companies with a history of growing their dividends; its dividend is not high in absolute terms. I also included a position in T. Rowe's S&P 500 fund; while not as inexpensive as some rival S&P 500 trackers, it gives the portfolio exposure to sectors that the Dividend Growth fund is light on, such as technology. T. Rowe Price Mid-Cap Growth and Mid-Cap Value are closed to new investors, so I used a small position in T. Rowe Price Diversified Small Cap Growth to give the portfolio exposure to the small-cap row of the style box. For foreign-stock exposure, I used the Bronze-rated T. Rowe Price Overseas Stock; because it lacks significant small- and mid-cap and emerging-markets exposure, I added a small position in T. Rowe Price International Discovery. Finally, I added a small position in T. Rowe Price Real Assets to supply inflation protection; the fund focuses on natural-resources stocks and REITs. Investors aiming to simplify could reasonably stick with the two core equity positions--Dividend Growth and Overseas Stock--and skip some of the smaller positions. 

Moderate Bucket Portfolio
Anticipated Time Horizon: 20 or more years 

This portfolio contains the same holdings as the aggressive T. Rowe portfolio, differing only in its allocations to them. Because it's geared toward retirees with shorter time horizons, it includes larger positions in high-quality short- and intermediate-term bonds and smaller positions in equities. To help reduce volatility, it omits the position in T. Rowe Price International Discovery. 

Bucket 1: Years 1-2
10%: Cash (money market funds and accounts, CDs, checking and savings accounts, and so forth; specific percentages will vary based on the amount of assets and the retiree's spending rate) 

Bucket 2: Years 3-10
10%: T. Rowe Price Short-Term Bond
10%: T. Rowe Price Inflation-Protected Bond
20%: T. Rowe Price New Income 

Bucket 3: Years 11 and Beyond
20%: T. Rowe Price Dividend Growth
10%: T. Rowe Price Equity Index
5%: T. Rowe Price Diversified Small Cap Growth
5%: T. Rowe Price Real Assets
10%: T. Rowe Price Overseas Stock 

Conservative Bucket Portfolio
Anticipated Time Horizon: 20 or more years 

In contrast with the aggressive and moderate portfolios, both of which emphasize growth to varying extents, this portfolio is geared toward older retirees with shorter time horizons. As such, its focus is on preserving purchasing power and funding living expenses; capital appreciation is secondary. Because its growth prospects are relatively low, it would not be appropriate for younger retirees unless they are extremely risk-averse and--more importantly--have more than enough money to last throughout their retirement years. 
 

Bucket 1: Years 1-2
12%: Cash (money market funds and accounts, CDs, checking and savings accounts, and so forth; specific percentages will vary based on the amount of assets and the retiree's spending rate) 

Bucket 2: Years 3-10
13%: T. Rowe Price Short-Term Bond
10%: T. Rowe Price Inflation-Protected Bond  
25%: T. Rowe Price New Income 

Bucket 3: Years 11 and Beyond
20%: T. Rowe Price Dividend Growth
10%: T. Rowe Price Equity Index
10%: T. Rowe Price Overseas Stock

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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