A Midyear Bucket Portfolio Checkup

Investors typically hold bonds to provide stability and a modicum of income, to serve as ballast for higher-returning/higher-volatility stocks. But occasionally the opposite performance pattern prevails: Losses in a portfolio come from the bond side of the house, not from stocks. Such was the case in the first half of 2018.

Indeed, the Federal Reserve's interest-rate hikes--two in 2018's first half with two more likely on the way before the year is over--are the primary explanation for performance in my bucket retirement portfolios so far this year. Despite decent, albeit unspectacular, returns in the portfolios' equity holdings, those gainers were offset by more rate-sensitive bond positions. Those countervailing forces led to flat or modestly negative results across all six of the core Bucket portfolios. (There are three portfolios for mutual fund investors--Aggressive, Moderate, and Conservative--and Aggressive, Moderate, and Conservative portfolios for retired ETF investors.)

A Bucket Strategy Review Before we delve into the Bucket portfolios' performance, let's first review what the Bucket approach is designed to do. As pioneered by financial planner Harold Evensky, the Bucket strategy for retirement portfolios centers around an extraordinarily simple premise: By holding enough cash to meet living expenses during periodic weakness in stock or bond holdings--or both--a retiree won't need to sell fallen holdings. That leaves more of the portfolio in place to recover when the market eventually does.

In each of my Model Bucket Portfolios, I've included three buckets that are invested based on withdrawal horizon in a worst-case scenario. Bucket 1 holds the aforementioned cash for near-term portfolio withdrawals--anywhere from six months' to two years' worth of portfolio withdrawals. Meanwhile, Bucket 2 consists primarily of bonds (amounting to eight years' worth of portfolio withdrawals), which offer higher long-term returns than cash with much lower volatility than stocks. Bucket 3 is the longest-term component of the portfolio, offering higher long-term return potential than Buckets 1 or 2 but with substantially higher expected volatility.

The beauty of the three-bucket setup is that holding cash and bonds at the "front end" of the portfolio provides an ample cushion of money to meet living expenses in case stocks fall and stay down for an extended period. Holding cash also provides peace of mind, though it also has the potential to weigh down results in periods of strong performance for stocks and bonds. (My Bucket "stress tests' have demonstrated that a Bucket portfolio with a cash component would have underperformed a fully invested portfolio with the same basic asset allocation from 2000-2017.)

Note that these portfolios are designed to be customized based on a retiree's own expected portfolio withdrawals. For example, a retiree who's withdrawing $30,000 per year from his or her portfolio would earmark anywhere from $15,000 to $60,000 in cash (six months' to two years' worth of withdrawals), another $240,000 in bonds (eight years' worth of withdrawals), and the remainder in stocks. This article takes a closer look at customizing your own Bucket portfolios.

Mutual Fund Bucket Portfolio Performance

Performance Recap Aggressive Mutual Fund Bucket Portfolio: -0.05% (YTD through 6/30/2018) Moderate Mutual Fund Bucket Portfolio: 0.17% (YTD through 6/30/2018) Conservative Mutual Fund Bucket Portfolio: -0.15% (YTD through 6/30/2018)

Of the three Bucket portfolios composed of traditional mutual funds, the Aggressive and Conservative portfolios posted tiny losses in the first six months of 2018. The Moderate portfolio made it into the black, but just barely. The Conservative portfolio, which is geared toward retirees with time horizons of 15 years and holds more than 50% of its assets in bonds and another 12% in cash, performed the worst of the three portfolios over the past six months. Its bond holdings experienced losses, especially in the year's first quarter, while it benefited less than its counterparts from a decent equity market environment. I might've expected the Aggressive portfolio, which features a 60% equity weighting, to fare the best of the three so far this year, but its larger allocation to foreign stocks was a drawback relative to the Moderate portfolio.

Best Performers

One bright spot in the Moderate and Conservative portfolios was their small positions in

, which is why I've maintained modes positions in the portfolios.

Meanwhile, the Aggressive and Moderate portfolios got at least a small boost from their positions in

Worst Performer

ETF Bucket Portfolios

Performance Recap Aggressive ETF Bucket Portfolio: -0.36% (YTD through 6/30/2018) Moderate ETF Bucket Portfolio: -0.16% (YTD through 6/30/2018) Conservative ETF Bucket Portfolio: -0.50% (YTD through 6/30/2018)

All of the ETF Bucket portfolios experienced small losses in 2018's first half. As with the mutual fund portfolios, the Moderate ETF portfolio held its ground better than its Aggressive and Conservative counterparts.

Best Performer:

As with the mutual fund portfolios, the ETF portfolios' positions in

Worst Performers:

iShares JP Morgan USD Emerging Markets Bond EMB was the worst performer in all three portfolios, losing more than 6% for the year to date through June. As a dollar-denominated fund, it hasn't been hurt by foreign-currency exposure--the bane of many foreign-bond funds amid the dollar's strength. But emerging markets bonds as a group have struggled in 2018, roiled by tariff concerns and rising rates in the U.S. (Higher rates on safe bonds tend to cut into demand for riskier bonds like emerging markets.) It's a fairly small position in all three portfolios, so the damaged was contained.