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A Bucket Approach in Practice

Christine Benz

Christine Benz: I'm Christine Benz for Morningstar.com.

The bucket approach to retirement planning is an increasingly popular strategy. Joining me to discuss it is Roger Wohlner; he is a financial planner at Asset Strategy Consultants in Arlington Heights, Ill.

Roger, thank you so much for being here.

Roger Wohlner: Well, thank you, Christine.

Benz: Roger, you actually use the bucket strategy, or version of it, when working with clients. I'd like to talk about how you segment the buckets. So, let's start with that first bucket number one, the cash bucket. Yields are really low right now. So, there is a risk of having too much in terms of living expenses in that bucket number one, but how do you work with clients on what goes in there and how big it should be?

Wohlner: That's a great question, and there is no single answer. It's a client-by-client type of situation. And when we say "bucketing," I used it in the context of what total asset allocation approach for their portfolio. But typically, the cash bucket or the real low-risk bucket, which could also be things like short-term bonds or that type of thing, that's a lot driven by a combination of how much money the client has, what their income needs are, and what they need to sleep at night.

So, it might be one year or might be two years, three years, but what I like to set up for most clients in retirement is, no matter what the market is going to do, even a 2008-2009 scenario, you're going to have this layer of cash or very, very low-risk investments, where you can draw on that versus having to sell into a down market--and that I think is a key thing.

So, again, it's a combination of factors, but I think it's very important to a lot of clients, because it gives them the confidence then to say, you also have these longevity needs, and inflation even at its current benign levels will erode your spending power in 20-25 years. So that gives them the confidence so we can then go to the other bucket and say, here is your stock portion, here is your medium-risk portion, which may be dividend-type stocks or may be bonds, or … alternative type of funds. So, that's really how I use the bucket approach in retirement.

Benz: Let's move on to that second piece; you alluded to it being the intermediate piece of the portfolio. Let's talk about what is going into that bucket number two at this juncture, particularly given how low bond yields are, the prospect of rising interest rates. What are you telling clients to use as their next-line reserves, once they've exhausted that bucket number one?

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Wohlner: Bucket number two had been--and we've done very well the last few years, as I'm sure a lot of advisors have for their clients--with intermediate-term bond funds and things like that. I've been shortening duration on bonds, whether individual or bond funds, and certainly I use several I'll call them alternative-type mutual funds in that bucket as well. So, that really isn't changing. It just might be the composition a little bit more, and maybe the types of returns we were getting out of that bucket are going to be a little bit lower going forward. From coming out of early 2009, intermediate-bond funds and TIPS were a no-brainer. And certainly, we will continue to use some of those things. It's just kind of a different allocation there.

Benz: Let's discuss the size of that next-line reserve, the intermediate-term bucket. I imagine you're going to say it depends on the client and depends on what their time horizon is and so forth. But typically, how much would you stake in that intermediate-term piece?

Wohlner: Well, looking at it more maybe from a total portfolio approach, a retired client is probably going to have 45% to 60% of their allocation in stocks, depending upon their growth needs, their age, and all their other sources of income. And … then if you go to the first bucket, that could be anywhere from one to four years or whatever the client is comfortable with. So, some portion of 55% to 40% is going to be in that second bucket. So maybe that's 30%, maybe it's 35%, 40%. It's really going to be part of the total allocation, and it's going to really depend on the other two layers. And I'm not saying I do it by default, but it's really taking a total risk approach to the portfolio and making sure that they have the cash that they are going to need to allow them to sleep at night and be able to do the things they want.

Benz: Are you hearing from clients that they're really worried about bonds at this juncture and maybe just want to hold dividend-paying stocks and other securities in lieu of the bonds that might typically populate bucket number two?

Wohlner: Actually, I think I'm bringing that more to my clients' attention than they're bringing it to mine. I think they're more worried about the stock market, the fact that it's done so well and they're nervous that we might have a repeat of 2008-2009.

Benz: Let's move on to the third bucket, the growth piece of the portfolio, I assume. Is that mainly stocks or do you put some other types of securities in that?

Wohlner: It's mainly stocks. And I do ETFs and funds. So, it is some combination of index products and some actively managed funds that I think add value. But it's stocks. It's domestic, international, large cap, small, mid-cap, etc.

Benz: When you think about any additional buckets, do you use any extra buckets, like for emergency fund expenses, or is this pretty much the extent to which you would employ buckets within client portfolios?

Wohlner: That's the extent that I would do it within the client portfolios, because often clients …[are] spending some of their day-to-day spending cash off in a bank account and that type of thing. But clearly, we do have an emergency component, whether it's implicit or explicit in that first bucket.

We look at their typical spending. We look at the types of things that pop up. … Obviously, the furnace going out is probably not going to be a killer for most of my clients. But you do look at emergencies or things even that you anticipate, like replacing a car down the road, that's $20,000, $25,000 or whatever the case may be.

So, I guess the answer to your question is, most of my clients have cash off to the side for their daily spending, and then they will take the money from their portfolio, that bucket, and then put it in their bank account and spend it.

Benz: Then for legacy planning, is that typically in bucket three if there is anything leftover at the end of life?

Wohlner: That varies. I have some clients that don't have children. I have some clients [for whom] that's very important. I have one client that has an inherited stock portfolio that's still at a very low basis, and so I think a lot of that it is meant for their children. So, it really varies by clients. For clients with children, we do try to set up the inherited IRAs as well, because those who have been a good tool.

So, it really depends on the client situation. I know, we say "it depends" a lot in financial planning, but everything is client specific. There is no one right answer. There are a couple of clients that, I think, if they had a camper, it would have a bumper stick on it saying, I'm spending my kids' inheritance, and that's OK, too.

Benz: OK, Roger. Thank you so much being here to discuss the bucketing strategy and your practical implementation of it.

Wohlner: Thank you, Christine.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.