This stock-heavy portfolio is appropriate for retirees with long time horizons and ample risk tolerance.
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By Christine Benz | 07-29-16 | 11:00 AM | Email Article

The current low-yield environment makes it a challenging time to wring income from a portfolio. Some income-focused investors have ventured further onto the risk spectrum to generate a livable yield; a smaller segment has been sticking with safer sources of income but trying to make do on less. 

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.

The bucket approach to generating living expenses from a portfolio during retirement aims to meet those challenges head on. The basic strategy is that a retiree holds the bulk of her assets in a long-term portfolio that's diversified between stocks and bonds. She then augments it with a cash bucket that she uses for spending money, and periodically refills that cash bucket with income distributions, rebalancing proceeds, or both. 

This aggressive bucket portfolio is composed of traditional mutual funds. With a roughly 50% equity position and the remainder in cash and bonds, the portfolio is more stock-heavy than other in-retirement portfolios. It's geared toward younger retirees who are comfortable with the higher volatility that accompanies an equity-heavy mix.

Bucket Basics
The central idea of the bucket strategy, as envisioned by financial-planning guru Harold Evensky, is to include a cash bucket to cover near-term cash needs. Over time, the cash bucket will weigh on the portfolio's performance, as longer-term assets (stocks and bonds) will tend to generate better returns. The big benefit of the cash cushion, however, is that it provides peace of mind for a retiree to know that assets for pending expenses are safely segregated from the more volatile assets in the portfolio. Even in a scenario in which the stock portion of the portfolio dropped precipitously, the retiree could spend the cash in bucket one and even move into the portfolio's next-line reserves--short-term bonds--without having to sell any stocks at a low ebb. 

This particular portfolio is geared toward retirees who expect to live 25 or more years in retirement. As with all of my portfolios, its goal isn't to generate the best returns of any retirement portfolio on record, but rather to help retirees and pre-retirees visualize what a long-term, strategic total-return portfolio would look like. Thus, a newly retired investor could follow the basic bucket concept without completely upending existing favorite holdings. 

The portfolio includes three buckets geared toward the near, intermediate, and long term. 

Bucket 1: Years 1-2

  • 8%: Cash (certificates of deposit, money market accounts, and so on)

The goal of this portion of the portfolio is to provide money for cash needs in years one and two of retirement, so we're not taking any risks with it. The yields on true cash instruments are currently comparable with those of short-term investments that don't ensure principal stability, so there's no sense in going with something that's not FDIC-insured. 

Bucket 2: Years 3-10

  • 8%:  Fidelity Short-Term Bond
  • 10%:  Harbor Bond  
  • 4%: Vanguard Short-Term Inflation-Protected Securities
  • 10%:  Vanguard Wellesley Income


This portion of the portfolio is designed to deliver slightly more income than bucket one, as well as a dash of inflation protection and capital appreciation. The Fidelity Short-Term Bond fund is there if, in a worst-case scenario, bucket one were depleted and rebalancing proceeds and/or income from the portfolio were insufficient to meet living expenses.

Despite the prospective headwinds of rising interest rates, I'm still comfortable with the fact that this portion of the portfolio is anchored in bonds. The linchpin bond holding, Harbor Bond, may suffer some short-term volatility if and when rates rise again; indeed, it lost 3% when bond yields spiked during the summer of 2013. Over time, however, the fund should be able to make up short-term principal losses by swapping into higher-yielding bonds as they become available. 

Because this portion of the portfolio has a longer time horizon but is focused on fixed-income investments, inflation is more of a concern. Thus, I've included a fund that invests in Treasury Inflation-Protected Securities, which adjust their principal values upward to keep pace with the Consumer Price Index. The short-term Vanguard fund delivers the desired inflation protection without the extreme rate sensitivity that accompanies longer-duration TIPS.

Bucket 3: Years 11 and Beyond

Due to an anchor position in Vanguard Dividend Appreciation, which focuses on companies with a history of growing their dividends, the portfolio has a high-quality tilt that's appropriate for a retirement portfolio. (Note that the original version of this portfolio included a position in  Vanguard Dividend Growth , but that fund closed in late July 2016; we supplanted it with this like-minded index fund.) A smaller position in Vanguard Total Stock Market supplies exposure to sectors that tend to be underweight in the Vanguard fund, such as technology. I'm also comfortable with Harbor International despite the 2014 retirement of one of its comanagers, as the remaining three managers are experienced and have been steeped in the firm's disciplined, value-oriented approach. 

And even though I've previously voiced concern about investors' stampede into higher-yielding bond-market sectors, I'm not inclined to reduce the position in Loomis Sayles Bond at this point. For one thing, we're holding the fund with at least a 10-year time horizon in mind. Moreover, I like the fact that the fund isn't wedded to a single risky sector; its managers can venture into foreign-currency-denominated bonds, convertibles, high-yield bonds, and even stocks.

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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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