5 Questions About the Bucket Strategy

For some retired or soon-to-retire investors,

is a useful guide to organizing and extracting cash for living expenses in retirement. For other investors, the logistics of bucketing raise as many questions as they answer. Are they supposed to move money from bucket to bucket on a regular basis? Should they hold three buckets, or can they get away with just two--cash and everything else? And so on.

Below, I’ll tackle some of the bucket-related questions I received following

. (Readers can see all of my model portfolios--both for retirees and accumulators--

, along with related articles about bucket maintenance.

Q:

This whole thing seems way too complicated. Why not use a good all-in-one fund instead of all of those individual funds in a portfolio?

A:

There's a lot to be said for simplicity, especially as retirement draws close. Many retirees have better things to do with their time than monitoring individual holdings and managing a whole portfolio; fewer individual holdings mean there aren’t as many moving parts to oversee on a regular basis. Moreover, plain-vanilla, nontactical allocation funds often have a target allocation that they rebalance back to on a regular basis; for example,

Yet there's one limitation to all-in-one products. If the income from the portfolio is insufficient to meet his or her living expenses, trimming from appreciated portions of a portfolio is usually the best way to extract additional needed cash flows. But selling an all-in-one fund means that you're effectively selling stocks and bonds. As discussed

, that frequently isn't optimal. Rather, an investor who is making withdrawals should be able to improve the portfolio's results by being strategic about those withdrawals--that is, pulling from the appreciated portions of the portfolio (or at least those that haven't fallen as much) while leaving in place those positions that have not performed as well. To use a simple example, the investor who was selling Vanguard Balanced Index in 2008 to harvest cash was effectively selling both stocks and bonds, while the investor with a discrete stock fund and a discrete bond fund would have the latitude to tap bonds alone.

" that compared a multifund portfolio with a single-fund portfolio between 2000 and 2012 gave the edge to the multifund portfolio.

That said, an investor could simplify my portfolios by sticking exclusively with very broad market index funds for the core of the portfolio (total stock, total bond, and total international funds, for example) and eschewing some of the more narrowly focused options, such as commodities and a multisector bond fund.

discusses how the bucket approach might reasonably be streamlined.

Q:

Your mutual fund bucket portfolios employ funds from four distinct fund companies, which would entail setting about accounts with and receiving statements with each firm. Is there a way to simplify?

A:

Yes. Investors who would prefer to consolidate with a single firm can do so in a couple of ways. First, they could buy all of the funds through a brokerage firm such as Schwab or Vanguard, but they’d need to pay transaction fees to buy some of the funds. For example, an investor with a Vanguard account would need to pay up to $35 in transaction fees to buy

FSHBX. (Investors with larger asset levels at Vanguard would pay less.)

Alternatively, an investor could stick exclusively with funds from a single fund family and avoid all transaction fees. (My

,

, and

bucket portfolios are appropriate for such investors.) Finally, an investor could avoid transaction fees by using a brokerage platform and sticking exclusively with those funds that don't carry transaction fees; that was the thought behind my

.

Q:

Should I spend my cash out of bucket 1 to defray my living expenses, or only tap the cash in extreme markets?

A:

In

, I've assumed that the cash in bucket is used on an ongoing basis to fund regular outlays. Cash is then replenished at the end of the year with income distributions and/or the proceeds from trimming appreciated positions (rebalancing).

But that’s not the only way to do it. In

, the developer of the bucket approach to retirement portfolio planning, he said that he taps cash (bucket 1) for his clients only in extreme market environments, when it's not a good time to withdraw from stocks or bonds or when withdrawals from those sources are insufficient to meet cash-flow needs. In more normal years, he funds his clients' needed cash flows using rebalancing proceeds.

Q:

With the bucket system, do you spend the bonds until they're all used up? Wouldn't it be better to spend stocks when they're up and spend bonds when stocks are down?

A: Investors frequently assume that the bucket approach entails "spending through" the various buckets--first cash, then bonds (bucket 2), then stocks. But that's not desirable for a few reasons. First, such a strategy would leave a retiree with an increasingly aggressive portfolio. True, research conducted by financial planning experts Michael Kitces and Wade Pfau suggested that an asset allocation that grows more aggressive with time can help retirees avoid "sequence of return risk"--encountering a bum market early in retirement. But an increasingly aggressive portfolio might create behavioral challenges, as many older retirees prioritize being able to sleep easily over growing their nest eggs. Perhaps more important, spending down cash and bonds first has the potential to leave an investor with a very aggressive, stock-heavy portfolio at a time when it's not opportune to draw from it because stocks are depressed. For that reason, I like the idea of using income and rebalancing proceeds to help supply liquidity to the portfolio on an ongoing basis. Rebalancing to a target allocation also serves to keep the portfolio from skewing to a single asset class over time, as depleting the buckets sequentially would tend to do. Q: Do the portfolios assume I'm using an IRA or some other tax-deferred account? A: I developed my original bucket portfolios, both mutual fund and ETF, for tax-deferred accounts--that is, they contain security types such as taxable bonds and commodities that will have high year-to-year tax costs. I developed the tax-efficient portfolios for taxable accounts.