We recap 2016 portfolio performance, as well as leaders and laggards.
By Christine Benz | 02-05-17 | 05:00 AM | Email Article

One of the best aspects of a "bucket approach" to retirement-portfolio allocation is that retirees aren't strictly beholden to the income streams their portfolios kick off. Rather, they can be opportunistic about where they go for cash flow, sourcing it from the sale of highly appreciated securities as well as stock dividends and bond income.

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.

Years like 2016 provide a vivid illustration of the benefits of shedding the income-centric mindset. Yields slunk lower through the first half of 2016, as investors bid up Treasuries amid concerns over slowing global growth. And even though bond yields jumped in the year’s second half, they remain low by historical norms. At just 2.45% at year-end 2016, the yield on the 10-year Treasury is well below the 4% that many planners think of as a starting point for sustainable spending in retirement.

Thankfully, last year's equity-market appreciation leaves bucket investors with other options. All of my model portfolios enjoyed healthy gains in their stock holdings last year. Thus, retirees employing this approach can rebalance their portfolios, reducing equities and pushing the proceeds into bucket 1 (cash) to meet living expenses for the next year or two. Any additional rebalancing proceeds can go into bonds. In so doing, they can shake cash flows out of their portfolios while also reducing risk.

Note that the goal of these model portfolios isn't to beat any other retirement strategy in existence, but rather to illustrate how investors can use a balanced, total-return-oriented portfolio to meet their cash flow needs. Investors shouldn't construe the bucket portfolios as a call to upend their own holdings; rather, if they hold a mix of sturdy equity and bond holdings, they already own most of the key ingredients for a bucket portfolio.

Nonetheless, I think it's a good practice to periodically review the portfolios--what has worked recently, as well as what hasn't, and discuss any portfolio changes that occurred over the past year. To help assess performance, I used a blended benchmark consisting of plain-vanilla indexes that mirrors the asset allocations of my portfolios. (That strikes me as the most intellectually honest way to benchmark a portfolio.)

You can find a complete listing of my bucket portfolios, as well as a discussion of how the bucket strategy works and how to maintain a bucket portfolio, here. Note that I'll be revisiting my annual "bucket stress tests" in the near future; the latest version of that exercise is here.

Aggressive Bucket Portfolio (Mutual Funds)

8%: Cash
8%: Fidelity Short-Term Bond
10%: Harbor Bond
4%: Vanguard Short-Term Inflation-Protected Securities
10%: Vanguard Wellesley Income
10%: Vanguard Total Stock Market Index
24%: Vanguard Dividend Appreciation
13%: Harbor International
8%: Loomis Sayles Bond
5%: Harbor Commodity Real Return

2016 Total Return: 6.18%

Blended Benchmark Return: 7.00%

Portfolio Changes: Replaced Vanguard Dividend Growth (closed) with Vanguard Dividend Appreciation

Not surprisingly, the aggressive bucket portfolio, with more than half of its assets in equities, outperformed the moderate and conservative bucket portfolios in last year's big stock-market runup. But the portfolio lagged a portfolio of simple index funds mirroring its asset-class exposures. The bucket portfolio's conservative-leaning U.S. equity portfolio held back results in a market environment that generally favored higher-risk assets. Vanguard Dividend Growth, which was in the portfolio until it closed in late July, badly lagged the index last year. I swapped in Vanguard Dividend Appreciation for Vanguard Dividend Growth when the latter closed, not because I was overly bothered by the latter's performance; to the contrary, I like the high-quality complexion and lower-volatility track records of both Dividend Growth and Dividend Appreciation. Those characteristics are particularly attractive given that the current equity-market rally is one of the longest-running in history. I expect the two funds to earn their keep on the downside by losing less than the broad market. My Aggressive portfolio made up some ground with its noncore fixed income positions, as Loomis Sayles Bond pitched in particularly strong gains. The commodities-tracking fund also contributed strong gains (for a change) but it's a small position so did not have a meaningful impact on returns.

Moderate Bucket Portfolio (Mutual Funds)

10%: Cash
10%: Fidelity Short-Term Bond
5%: Fidelity Floating Rate High Income
15%: Harbor Bond
5%: Vanguard Short-Term Inflation-Protected Securities
5%: Vanguard Wellesley Income
20%: Vanguard Dividend Appreciation
10%: Vanguard Total Stock Market
10%: Harbor International
5%: Loomis Sayles Bond
5%: Harbor Commodity Real Return

2016 Total Return: 5.89%

Blended Benchmark Return: 6.53%

Portfolio Changes: Replaced Vanguard Dividend Growth (closed) with Vanguard Dividend Appreciation

As with the Aggressive portfolio, Vanguard Dividend Growth dragged on returns relative to a plain-vanilla equity index-fund benchmark last year. While Vanguard Dividend Growth notched a respectable 7.5% gain, that was more than 4 percentage points behind the S&P 500 Index. Positions in Loomis Sayles Bond and Fidelity Floating Rate Income both contributed positively to relative performance. (For my blended benchmark, I used a Barclays Aggregate tracker for the fixed income exposure.)

Conservative Bucket Portfolio (Mutual Funds)

12%: Cash
12%: Fidelity Short-Term Bond
5%: Fidelity Floating Rate High Income
20%: Harbor Bond
6%: Vanguard Short-Term Inflation-Protected Securities
5%: Vanguard Wellesley Income
23%: Vanguard Dividend Appreciation
7%: Harbor International
5%: Loomis Sayles Bond
5%: Harbor Commodity Real Return

2016 Total Return: 5.10%

Blended Benchmark Return: 5.25%

Portfolio Changes: Replaced Vanguard Dividend Growth (closed) with Vanguard Dividend Appreciation

This was the worst-performing of the three mutual fund bucket portfolios in absolute terms. With higher allocations to cash and bonds, its returns were muted in last year's equity-market rally. The Conservative bucket portfolio nearly matched its blended benchmark in 2016, however, largely because its equity exposure is a smaller percentage of the portfolio than is the case for the Moderate and Aggressive bucket portfolios. As a result, Vanguard Dividend Growth was less of a drag on relative performance. The bond funds in this portfolio are the same as in the Moderate portfolio; the Conservative portfolio got a similar shot in the arm from Loomis Sayles Bond and Fidelity Floating Rate High Income.

Aggressive Bucket Portfolio (ETFs)

8%: Cash
8%: Vanguard Short-Term Bond Index
10%: PIMCO Total Return Active ETF
4%: Vanguard Short-Term Inflation-Protected Securities
35%: Vanguard Dividend Appreciation
10%: Vanguard Total Stock Market ETF
12%: Vanguard FTSE All-World ex-US ETF
5%: SPDR Bloomberg Barclays High Yield Bond ETF
3%: WisdomTree Emerging Markets Local Debt
5%: PowerShares DB Commodity Index Tracking

2016 Total Return: 8.48%

Blended Benchmark Return: 7.63%

Portfolio Changes: None

Because the ETF bucket portfolios have ample weightings in plain-vanilla index funds themselves, I expect their performance to track their blended benchmarks more closely than the mutual fund portfolios. The ETF portfolios benefited from holding Vanguard Dividend Appreciation --versus Vanguard Dividend Growth--for the entire calendar year; the former kept pace with the broad market, whereas Dividend Growth lagged. The bond holdings in the ETF portfolios also added to performance. While a Barclays Aggregate Index tracker is a perfectly reasonable core holding, I've used the actively managed ETF, PIMCO Total Return , to supply core fixed-income exposure in the ETF bucket portfolios. PIMCO Total Return outpaced the index by a small margin last year. Meanwhile, small positions in bank-loan and junk bond ETFs, as well as a local-currency-denominated emerging-markets bond fund, kicked in even stronger gains.

Moderate Bucket Portfolio (ETFs)

10%: Cash
10%: Vanguard Short-Term Bond Index
5%: PowerShares Senior Loan ETF
15%: PIMCO Total Return ETF
5%: Vanguard Short-Term Inflation-Protected Securities
25%: Vanguard Dividend Appreciation
10%: Vanguard Total Stock Market ETF
10%: Vanguard FTSE All-World ex-US
2.5%: SPDR Barclays High Yield Bond ETF
2.5%: WisdomTree Emerging Markets Local Debt
5%: PowerShares DB Commodity Index Tracking

2016 Total Return: 7.39%

Blended Benchmark Return: 6.66%

Portfolio Changes: None.

The Moderate ETF bucket portfolio benefited from some of the same factors that gave the Aggressive ETF portfolio a boost last year. The portfolio's noncore fixed-income exposures, in particular, boosted relative returns alongside the blended benchmark.

Conservative Bucket Portfolio (ETFs)

12%: Cash
10%: Vanguard Short-Term Bond Index
5%: PowerShares Senior Loan Portfolio
20%: PIMCO Total Return ETF
8%: Vanguard Short-Term Inflation-Protected Securities
28%: Vanguard Dividend Appreciation
7%: Vanguard FTSE All-World ex-US
2.5%: SPDR Barclays High Yield Bond ETF
2.5%: WisdomTree Emerging Markets Local Debt
5%: PowerShares DB Commodity Index Tracking

2016 Total Return: 6.10%

Blended Benchmark Return: 5.74%

Portfolio Changes: None.

Like the Aggressive and Moderate ETF portfolios, this portfolio stayed comfortably ahead of its blended benchmark last year. Despite ample holdings in low-returning short-term bonds, both a nominal short-term ETF and one that focuses on short-term TIPS, the portfolio's noncore fixed-income positions delivered strong gains.

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