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Investing Specialists

A Moderate ETF Bucket Portfolio for Retirement

This portfolio is geared toward retirees with roughly 20-year time horizons.

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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. (That said, this particular portfolio is geared toward investors' tax-sheltered accounts, because it holds taxable bonds.)

My portfolios are strategic in nature--that is, I won't jockey around in an effort to benefit from what has recently prevailed in the market, or what might perform well in the near future. Rather, I take a hands-off approach to asset allocation. However, I will make changes to the portfolios when fundamental considerations dictate or when better options become available; I would also urge investors to engage in regular rebalancing to reduce their portfolios' risk levels ant to keep bucket 1 topped up.

Bucket Basics
My Moderate ETF Bucket Portfolio is geared toward retirees with a roughly 20-year time horizons (that is, life expectancy) and moderate risk capacities. It stakes roughly 45% of assets in stocks and the remainder in cash and bonds.

As with the other portfolios, I've divided this portfolio into three components: the cash component in Bucket 1; Bucket 2, consisting of bonds and a high-quality dividend-focused fund; and a long-term growth sleeve in Bucket 3.

Bucket 1: Years 1-2
10%: Cash (certificates of deposit, money market accounts and funds, and so on).

The goal of Bucket 1 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. Money market mutual funds, while only implicitly guaranteed, also fit the bill. 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
7.5%:  Vanguard Short-Term Bond Index ETF (BSV)
12.5%:  Vanguard Short-Term TIPS ETF (VTIP)
7.5%:  Fidelity Floating Rate High Income (FFRHX)
15%:  iShares Core Total USD Bond (IUSB)
12.5%:  Vanguard Dividend Appreciation Index ETF (VIG)

This portion of the portfolio is dominated by bond holdings, but it also includes some high-quality equity exposure to provide a bit of growth potential to this portion of the portfolio.

Bucket 2 is stair-stepped by risk level, starting with short-term bond funds to serve as next-line reserves if cash is depleted and income distributions and/or rebalancing proceeds are insufficient to meet living expenses. Its core bond position is iShares Core Total USD Bond, which is dominated by high-quality bonds but also includes a dash of lower-quality exposure.

For the higher-risk component of Bucket 2, I've used Fidelity Floating Rate High Income, which focuses on floating-rate senior loans. I went with an actively managed fund here, because there aren't any Medalist ETFs in the bank-loan category. I also employed a high-quality equity exposure to provide a bit of growth potential to this portion of the portfolio. 

Bucket 3: Years 13 and Beyond
10%:  Vanguard Dividend Appreciation Index ETF (VIG)
10%:  Vanguard Total Stock Market ETF (VTI)
10%:  Vanguard FTSE All-World ex-US ETF (VEU)  
2.5%:  Vanguard High-Yield Corporate (VWEHX)
2.5%:  iShares JP Morgan USD Em Markets Bond (EMB)

Equities dominate the long-term component of the portfolio, but Bucket 3 also includes smaller positions in high-risk/high-reward bond types. 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 mutual fund bucket portfolios all employed  Loomis Sayles Bond (LSBRX) for their "aggressive kicker" bond positions, there's no analog among ETFs. For this portion of the portfolios, I employed a hedged emerging-markets bond fund ETF, as well as an actively managed high-yield fund. It may seem incongruous to feature an active fund in an ETF portfolio, but our analysts have concluded that high-yield is an area that can’t readily be indexed. Plus, Vanguard's actively managed high-yield fund is cheaper than its index counterparts.

 

Christine Benz does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.