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Investing Specialists

Retirement 'Bucket' Portfolios for Schwab Supermarket Investors

Worthy stock options are plentiful, but some of our favorite bond choices aren't here.

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Editor's note: These portfolios were reviewed on June 10, 2019.

In previous articles, I've discussed how Fidelity, Vanguard, and T. Rowe Price investors can create Bucket retirement portfolios consisting exclusively of the house brand of mutual funds.

But what about investors who would like the latitude to graze among fund companies--a T. Rowe Price fund there, an Oakmark fund there, and a Loomis Sayles fund thrown in for good measure?

Of course, most brokerage firms allow investors to pick and choose funds from various mutual fund providers, just as they can pick and choose individual stocks; investors may also be able to trade in certain funds without paying loads or transaction fees. Likewise, big fund shops like Fidelity, Vanguard, and T. Rowe Price all have brokerage arms that allow investors to buy not just the house brand of funds, but funds from other shops, too, as well as individual stocks and ETFs.

But Charles Schwab created the first mutual fund supermarket, and it's still the big kahuna in this space. While the firm has its own lineup of funds--including a solid suite of low-cost index funds and ETFs--fund investors know it as a way to buy funds from smaller shops without having to maintain many small accounts. For years, fund shops viewed placement on the Schwab supermarket shelves as their shot at the big time; the Schwab connection gave them reach that they'd be unable to earn on their own. (Of course, funds offered on a no-transaction-fee platform have to pay for that privilege by sending a portion of their expense ratios to the supermarket.)

This week, I'll take a look at how an investor might build a Bucket retirement portfolio using the Schwab platform. For these portfolios, I've employed only those funds that are available without transaction fees or loads on Schwab's OneSource platform. However, it's worth noting that for buy-and-hold investors, paying a transaction fee may sometimes be cost-effective. Yes, the investor has to pay $76 to initiate a position in a non-NTF fund, but that cost can be quickly recouped if the non-NTF fund is cheaper than a similar fund that's available without a transaction fee. 

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. Bucket 1 lives alongside a long-term portfolio consisting of stocks and bonds; the main benefit of the cash is to provide peace of mind to help the retiree tolerate the fluctuations that will inevitably accompany the long-term 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.

Of course, there's an opportunity cost to Bucket 1--it's a loser on a post-inflation basis--which is the key reason that I've limited it to two years' worth of living expenses. It's also important to note that the allocations in these portfolios are approximations; investors will want to use their own anticipated spending rates to influence the size of Bucket 1 and, in turn, the size of the other buckets. For example, the investor who expects to spend just $30,000 of her $1 million portfolio each year would hold $60,000, or 6% of her total portfolio, in Bucket 1, 24% (eight years' worth of living expenses) in Bucket 2, and the rest in Bucket 3. Her spending rate is low, so she can theoretically tolerate a more aggressive portfolio mix.

It's also worth noting that the goal of these portfolios 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.

Finally, investors should bear in mind that these portfolios are geared toward tax-sheltered accounts, so they include healthy doses of tax-inefficient bonds. 

Aggressive Bucket Portfolio
Anticipated Time Horizon: 25 or more years

Bucket 1: Years 1 and 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 1 will be used for near-term spending needs, safety is the name of the game; we're sticking with cash.

Bucket 2: Years 3-10
10%:  Baird Short-Term Bond (BSBSX)  
7%:  Schwab Treasury Inflation Protected Securities Index (SWRSX)  
15%:  Metropolitan West Total Return Bond (MWTRX)

Bucket 2, which consists of high-quality fixed-income holdings, was the most challenging bucket to populate using funds on the NTF Schwab platform. Many of Morningstar's Gold-rated bond funds do not have 12b-1 fees, which helps them keep their expense ratios down. Yet, many non-house-brand funds on supermarket platforms charge 12b-1s.

I employed the Gold-rated Metropolitan West Total Return Bond as the portfolio's core fixed-income position. I augmented it with positions in Baird Short-Term Bond and Schwab Treasury Inflation-Protected Securities. The former serves as next-line reserves in case cash is depleted and there's no ready source of income, whereas the latter supplies needed inflation protection.

Bucket 3: Years 11 and beyond
20%:  Oakmark Fund (OAKMX)
20%:  Schwab Total Stock Market (SWTSX)
15%:  American Funds International Growth and Income (IGIFX)
5%:  Loomis Sayles Bond (LSBRX)

Finding worthwhile equity funds is easy work on Schwab's NTF platform. While you won't find big Vanguard or Fidelity funds on offer, some terrific boutiques are represented on the list, and investors can also buy some funds that typically carry a sales charge on an NTF basis. I used Oakmark Fund, Gold-rated and a longtime Morningstar favorite, as the portfolio's core equity holding, though more risk-tolerant retirees could reasonably employ the more concentrated  Oakmark Select (OAKLX) instead. I augmented it with Schwab Total Stock Market to help smooth out the active fund's sector exposure, provide a dash of exposure to small- and mid-caps, and to lower the portfolio's overall costs. 

Gold-rated American Funds International Growth & Income is the portfolio's sole foreign-stock holding. The portfolio also includes small positions in Loomis Sayles Bond, to provide aggressive, noncore bond exposure.

Moderate Bucket Portfolio
Anticipated Time Horizon: 20 or more years

This portfolio contains the same holdings as the aggressive Schwab 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.

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%: Baird Short-Term Bond 
10%: Schwab Treasury Inflation-Protected Securities 
20%: Metropolitan West Total Return Bond

Bucket 3: Years 11 and Beyond
15%: Oakmark
15%: Schwab Total Stock Market Index
5%: Loomis Sayles Bond
15%: American Funds International Growth & Income

Conservative Bucket Portfolio
Anticipated Time Horizon: 15 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%: Baird Short-Term Bond  
10%: Schwab Treasury Inflation-Protected Securities 
25%: Metropolitan West Total Return Bond

Bucket 3: Years 11 and Beyond
10%: Oakmark Fund
10%: Schwab Total Stock Market Index
15%: American Funds International Growth & Income 
5%: Loomis Sayles Bond

Changes Since Portfolios' Inception
I've made some changes to the portfolios since their launch in 2015.

The short-term and inflation-protection slots in all of these portfolios were originally occupied by USAA Short-Term Bond (USSBX) and BlackRock Inflation Protected Bond (BPRAX), respectively. But those funds experienced management changes and analyst downgrades, prompting the switches into higher-conviction Medalist funds--Baird Short-Term Bond and Schwab Treasury Inflation-Protected Securities.

Diamond Hill Small-Mid Cap (DHMAX) occupied a 5% position in the original version of the Aggressive and Moderate portfolios, but I removed it and redeployed the assets into Schwab Total Stock Market after the Diamond Hill fund closed to new investors. (The portfolios are designed to be investable, so all holdings must be open to new investors.)

Harbor International (HIINX) was the original international equity fund in this portfolio, but I replaced it with American Funds International Growth and Income effective September 2018 following a manager departure, significant redemptions, and a large impending capital gain distribution.

Finally, while the original portfolio included aa small commodities position, I removed it in September 2018 to align more closely with Morningstar's Lifetime Allocation Indexes. 

Christine Benz has a position in the following securities mentioned above: OAKLX. Find out about Morningstar’s editorial policies.