How Did the Bucket Portfolios Perform in 2019?

In 2019, investors’ buckets runneth over.

Both bonds and stocks--the key components of buckets 2 and 3, respectively--enjoyed an extraordinarily good run last year. Thus, in early 2020, bucket investors have an opportunity to top up their cash buckets--bucket 1--to provide living expenses for the years ahead. In fact, trimming appreciated equity holdings can supply living expenses for not just 2020, but several years beyond that as well.

To use a simple example of how this might work in practice, let’s assume a 65-year-old couple started retirement at the beginning of last year with a $1 million bucket portfolio, planning to withdraw $40,000 (4%) of their portfolio in year 1 of retirement. If they were using a bucket approach and a 60% equity/40% cash/bond portfolio, they’d start 2019 with $80,000 in cash (two years’ worth of portfolio withdrawals); $320,000 in bonds; and $600,000 in stocks.

By year-end, though, their bucket 1 would be down to about $41,000, assuming they’ve earned a modest yield on their cash over the past year and they took their $40,000 withdrawal. Meanwhile, bucket 2 would have appreciated to nearly $340,000, assuming a very modest 4% rate of return. And the equity portfolio would have soared to $720,000, assuming an eminently doable 20% total return from that portion of the portfolio. If the investors planned to periodically rebalance appreciated holdings to refill bucket 1, trimming bucket 3 back to $600,000 (from $720,000) would supply the next three years’ worth of living expenses for bucket 1. That means that stocks and even bonds could undergo serious volatility without any repercussions for our hypothetical retirees' spending plan.

Of course, that’s a highly simplified example, holding three years' worth of living expenses in cash is arguably too much, and specific rebalancing and bucket-maintenance methods vary widely. But it’s still safe to say that bucket investors looking to raise cash and keep their portfolios’ risk levels in check have ample opportunities to do so following 2019, provided they maintained decent exposure to equities last year.

Not surprisingly, the most aggressively positioned of my bucket portfolios--the Aggressive Mutual Fund and ETF portfolios--performed best, with both gaining 19%. Their Conservative counterparts returned 13%-14%, but their gains were more than respectable in absolute terms. Because the asset allocations and risk exposures of the Mutual Fund portfolios are quite similar to their ETF analogs, performance was similar, too.

Aggressive Bucket Portfolio (Mutual Funds) 8%: Cash 8%: Fidelity Short-Term Bond FSHBX 10%: Harbor Bond HABDX 7%: Vanguard Short-Term Inflation-Protected Securities VTAPX 10%: Vanguard Wellesley Income VWIAX 10%: Vanguard Total Stock Market Index VTSAX 24%: Vanguard Dividend Appreciation VDADX 15%: American Funds International Growth & Income IGIFX 8%: Loomis Sayles Bond LSBDX

2019 Return: 18.54%

Moderate Bucket Portfolio (Mutual Funds) 10%: Cash 10%: Fidelity Short-Term Bond 5%: Fidelity Floating Rate High Income FFRHX 15%: Harbor Bond 10%: Vanguard Short-Term Inflation-Protected Securities 5%: Vanguard Wellesley Income 10%: Vanguard Total Stock Market Index 20%: Vanguard Dividend Appreciation 10%: American Funds International Growth & Income 5%: Loomis Sayles Bond

2019 Return: 15.95%

Conservative Bucket Portfolio (Mutual Funds) 12%: Cash 12%: Fidelity Short-Term Bond 5%: Fidelity Floating Rate High Income 20%: Harbor Bond 11%: Vanguard Short-Term Inflation-Protected Securities 5%: Vanguard Wellesley Income 23%: Vanguard Dividend Appreciation 7%: American Funds International Growth & Income 5%: Loomis Sayles Bond

2019 Return: 13.55%

Performance Recap Vanguard Total Stock Market Index was the top-performing holding across the portfolios, gaining more than 30%. Core equity holding Vanguard Dividend Appreciation, which I've employed for its high-quality focus and its history of below-market volatility, trailed the index by just a hair. The portfolio's biggest standout relative to its peers in 2019 was American Funds International Growth & Income, which soared in part because of its technology overweighting. Vanguard Wellesley Income also enjoyed a standout year, in no small part thanks to its interest-rate sensitivity in a year in which bond yields declined.

The discrete bond funds in the portfolios also performed well, especially the most aggressive options, such as Loomis Sayles Bond, which benefited from positivity about the economy’s health. But bonds in general posted a stellar year, buoyed by declining yields. Our core bond holding in the portfolios, Harbor Bond, trailed the Bloomberg Barclays Aggregate Index in 2019, but it posted strong gains in absolute terms.

In a reversal from 2018, cash was the worst-performing holding in any of the portfolios last year. (Cash was the lone bright spot in the portfolios in 2018.) But the cash is in place not as a return engine but to provide steady cash flows if the stock or bond components of the portfolios encounter turbulence.

Portfolio Changes: None

Aggressive Bucket Portfolio (ETFs) 8%: Cash 7%: Vanguard Short-Term Bond ETF BSV 10%: Vanguard Short-Term Inflation-Protected Securities VTIP 13%: iShares Core Total USD Bond Market ETF IUSB 28%: Vanguard Dividend Appreciation Index ETF VIG 13%: Vanguard Total Stock Market ETF VTI 15%: Vanguard FTSE All-World ex-US ETF VEU 3%: Vanguard High-Yield Corporate VWEAX 3%: iShares JPM Morgan USD Emerging Markets Bond EMB

2019 Return: 18.70%

Moderate Bucket Portfolio (ETFs) 10%: Cash 7.5%: Vanguard Short-Term Bond Index ETF 12.5%: Vanguard Short-Term TIPS ETF 7.5%: Fidelity Floating Rate High Income FFRHX 15%: iShares Core Total USD Bond 22.5%: Vanguard Dividend Appreciation Index ETF 10%: Vanguard Total Stock Market ETF 10%: Vanguard FTSE All-World ex-US ETF 2.5%: Vanguard High-Yield Corporate 2.5%: iShares JP Morgan USD Em Markets Bond

2019 Return: 15.92%

Conservative Bucket Portfolio (ETFs) 12%: Cash 13%: Vanguard Short-Term Bond ETF 15%: Vanguard Short-Term Inflation-Protected Securities 20%: iShares Core Total U.S. Bond Market 6%: Fidelity Floating Rate High Income 21%: Vanguard Dividend Appreciation ETF 7%: Vanguard FTSE All-World ex-US ETF 3%: Vanguard High-Yield Corporate Bond 3%: iShares JPMorgan USD Emerg Markets Bond

2019 Return: 12.68%

Performance Recap The performance of these three portfolios closely mirrors that of their mutual fund counterparts. As with the mutual fund portfolios, the Aggressive ETF bucket portfolio gained the most, thanks largely to its exposure to the total market index fund and Vanguard Dividend Appreciation. The portfolios also benefited from their exposure to lower-quality bonds, especially iShares JP Morgan USD Emerging Markets Bond and Vanguard High Yield. The latter isn't an ETF but rather an active fund; our analysts prefer active management in the high-yield space.

As with the mutual fund portfolios, cash and short-term bond holdings performed less impressively, but they're in place to provide stability, and cash flows to the portfolios, not growth.

Portfolio Changes The sole change to the portfolio was to swap in Fidelity Floating Rate High Income in place of SPDR Blackstone/GSO Senior Loan SRLN this past June. Morningstar downgraded the SPDR Blackstone ETF's Morningstar Analyst Rating from Bronze to Neutral, whereas the Fidelity fund holds a Bronze rating. Morningstar senior analyst Eric Jacobson points out that the Fidelity fund is no longer as distinctively risk-shy as it was under previous management teams, but notes that it's a competently managed moderate option in the floating-rate space.