A Moderate ETF Portfolio in 3 Buckets
This all-ETF portfolio is geared toward retirees with midrange time horizons and risk appetites.
Succession planning is important for CEOs, but did you know it's also important for your retirement portfolio?
Even if you're an extremely engaged investor--and that's true of many Morningstar.com readers--it's important to have a backup plan in case something should happen to you. Will your spouse know where to go for cash to pay the bills? Have you tried to skinny down your portfolio to as few moving parts as possible, especially if you're in your later retirement years?
That's where the bucket strategy, especially one involving exchange-traded funds or index mutual funds, can come in handy. The linchpin of the bucket approach is one to two years' worth of living expenses set aside in cash instruments. That way your household's near-term living expenses are covered regardless of what the market is doing.
And by using broad-market ETFs for the portfolio's long-term holdings, you're ensured low-cost diversification without having to worry about pesky issues like fund-manager departures or style slippage. Need to rebalance? By using broad-based index funds, you can easily determine which holdings to peel back on and where to add.
ETFs are attractive retirement holdings from a few other angles, too. Because many retirees have large shares of their portfolios in low-returning investments like cash and bonds, focusing on very low-cost investments is an easy way to enhance take-home returns. Moreover, equity ETFs can be more tax-efficient than even their plain-vanilla index fund counterparts (which are pretty tax-efficient themselves). That's an advantage to the many investors who come into retirement with sizable shares of their portfolios in taxable accounts.
My moderate ETF bucket portfolio uses the same general framework and assumptions as the moderate portfolio consisting of traditional mutual funds. It's geared toward a retired couple with a roughly 20-year time horizon (that is, life expectancy) and a moderate risk capacity. The aim of the portfolio is to meet their cash flow needs throughout their retirement years. It stakes roughly 45% of assets in stocks and the remainder in cash, bonds, and a small slice of commodities exposure.
Because their time horizon is shorter than the 30 years that underpins the 4% rule, they're using a slightly higher withdrawal rate of 5% in year one of retirement, with that amount inflation-adjusted each year thereafter. As bucket one becomes depleted, they can refill it using income from their dividend-producing equities and bonds, rebalancing proceeds, or a combination of the two.
As with the other portfolios, I've divided this portfolio into three components: the cash component (bucket one), bucket two consisting of bonds and a high-quality dividend-focused fund, and a long-term growth sleeve (bucket three).
Bucket 1: Years 1-2
The goal of bucket one is to hold principal steady to meet upcoming living expenses. Therefore, its assets are earmarked for guaranteed investments such as CDs and money market accounts. Because cash yields are currently so low, staking too much in so-called safe investments like these carries a sizable opportunity cost.
Bucket 2: Years 3-12
PIMCO Total Return is the core fixed-income position here. Although the firm has received scrutiny following the unexpected departure of Bill Gross, I like the idea of using an active manager who has the ability to shorten duration (a measure of interest-rate sensitivity) and otherwise diverge from the Barclays U.S. Aggregate Bond Index to protect on the downside. This portion of the portfolio also includes a position in a short-term bond ETF to serve as next-line reserves in case bucket one is depleted and neither income distributions nor rebalancing proceeds were sufficient to refill it.
In addition, this portion of the portfolio includes smaller sleeves in a bank-loan fund (PowerShares) as well as a short-term fund focused on Treasury Inflation-Protected Securities. It also includes a small position in a quality-conscious equity ETF.
Bucket 3: Years 13 and Beyond
Equities dominate the long-term component of the portfolio, but bucket three includes smaller positions in high-risk/high-reward bond types as well as a small stake in a commodities-tracking ETF. As in all of the portfolios, I've given the core U.S.-equity position a tilt toward quality by using a dividend-growth ETF as well as a total-market index ETF. (Minimalists could easily use a total-market index fund as their sole U.S. equity holding, however.)
Whereas the traditional U.S. equity portfolios all employed Loomis Sayles Bond (LSBRX) for their "aggressive kicker" bond positions, there's no analog among ETFs. Thus, I employed small stakes in a junk-bond and local-currency-denominated emerging-markets bond ETF.
Christine Benz does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.