Susan Dziubinski: Hi, I'm Susan Dziubinski for Morningstar. The Bucket approach to retirement portfolio planning has gotten more popular, but one size doesn't fit all when it comes to buckets. Joining me to discuss how to tailor a Bucket approach to suit your own situation, is Christine Benz. She's Morningstar's director of personal finance and retirement planning. Hi, Christine. Good to see you today.
Christine Benz: Hi, Susan. Good to see you, too.
Dziubinski: Let's start with sort of a basic outline of how the Bucket system works and how does it work and what are the pros and cons?
Benz: Sure. First of all, I always credit Harold Evensky, a financial planner and professor and financial planning, for really putting the bug in my ear about Bucket strategy so many years ago. And the basic idea is that you are holding cash in your portfolio to meet near-term living expenses. And then from there, you're kind of stepping out on the risk spectrum with your portfolio, and basically you're using your anticipated spending horizon to determine how much you would invest in each of the buckets. So, in my basic Bucket system, I've got two years worth of portfolio withdrawals in cash, I've got another five to eight years in basically a high-quality bond portfolio, and then the funds that you might use for the years beyond that are parked in equities. That's the basic framework. I think it's a very intuitive way of organizing a portfolio and kind of backing into a situation-appropriate asset-allocation mix. I would say that's the main positive of the Bucket approach. People really get it. I talk about it a lot, and I can kind of see the light bulb go off. I like that it takes something that's oftentimes really sort of black boxy, which is asset allocation, and I think it makes it intuitive and understandable. That's the major benefit to bucketing, in my view.
In terms of the major drawback, I would say it's that it can get a little bit complicated, especially in terms of keeping the buckets maintained on an ongoing basis. Unfortunately there's not any sort of set-it-and-forget-it bucket system. You need to keep things running along. You need to keep refilling that cash bucket as you spend from it. And that entails a little bit of art and science as you rebalance and draw income distributions and everything else. And then a further complicating factor is that most people aren't just bringing a single account into retirement. They're bringing oftentimes multiple accounts with different tax characteristics. And so marrying that three-bucket system with multiple accounts can further complicate things.
Dziubinski: Now you've built and maintained several different Model Bucket Portfolios on Morningstar.com. How do you suggest investors use those? Should they take them and just sort of run with it? Or how should they think about perhaps customizing that to their own situations?
Benz: I love the idea of people customizing these based on their own situations. And the way I would go about it is that I would start by thinking about my anticipated portfolio spending, and then I would look at all my nonportfolio sources of income. For a lot of us, this will be Social Security. For some people, although a shrinking share of the population, this will be a pension. You want to subtract out those nonportfolio income sources. And then the amount that you're left over with is the amount that you would be spending from that portfolio annually. And then you want to spend a little bit of time stress-testing that amount to make sure that it's sustainable. Our team and certainly lots of other researchers have looked at what's a sustainable withdrawal rate, but you'd want to make sure that whatever you're planning to take out does look sustainable over your anticipated in-retirement time horizon. But then use that amount, assuming that it is sustainable, to decide how much you drop into each of those buckets.
So if, for example, I determine that my portfolio spending is going to be $50,000 a year and I want to use a basic Bucket structure, I would have perhaps $100,000 in cash investments. And then I would graduate on to the more aggressively positioned buckets from there. But I would use my portfolio expenditure as kind of the key building block when I'm customizing a Bucket approach for myself.
Dziubinski: Now, you say that investors should also consider their nonportfolio income sources in retirement when they're sort of looking at how they might think about or maintain their buckets. What do you mean there?
Benz: Well, I mean they should not just look at how much they expect from those nonportfolio income sources which I just talked about, but also think about the timing of those nonportfolio income sources. One strategy we often talk about in the realm of retirement planning is the value of being able to delay Social Security filing. So, the net effect of that for a lot of retirees who plan to use that approach, is that their early years of retirement might be a little heavier in terms of their expenditures from their portfolio, and then it might lighten up when the Social Security benefits come online. You'd want to factor in just not how much you expect from those nonportfolio income sources, but also what the timing might look like. The net effect of that is that the complexion of your buckets, the composition of your buckets, might actually change throughout your retirement time horizon. You might start out with more in the safe stuff to meet your heavier spending in the early years of retirement if you are planning to delay Social Security, and then later on, you may be able to run with less in terms of conservative holdings because your portfolio spending is going down.
I would spend a little bit of time looking at not just how your spending might change through retirement, which is important in and of itself, but also looking at how those nonportfolio income sources fit in.
Dziubinski: And then, Christine, the Bucket system that you've been talking about is traditionally a three-bucket system, but you say there may be a case for some people for a fourth bucket. Let's talk about that.
Benz: Yeah, I think this is kind of an interesting concept, Susan, and we've talked about it a little bit before as well. But the basic ideas that you're building those three buckets to sustain you through your own life span and through your normal spending through that life span. But I think a fourth bucket could come in handy in a couple of instances. One would be if you do not have long-term-care insurance and you're concerned about long-term-care expenses later in life, it seems that potentially there could be utility in having that fourth bucket to house those long-term-care costs. So, you could invest it probably the most aggressively of your four buckets because you would probably tap those assets later in life. You might use kind of the probability and the duration of long-term-care expenses to decide how to invest that bucket. You might have, say, a couple of years worth of long-term-care needs housed within that bucket number four. I think it can have utility in that instance.
It can also make sense for people who want to definitely leave money to children or grandchildren or charity, who want to make sure that they've kind of hived off those assets from their spendable assets. And there again, I think there's a strong case for investing those assets quite aggressively, because those are sort of for the next generation or for your heirs. I think there are some ideas for being thoughtful about having a last-stop bucket in addition to those other three buckets that we've already talked about.
Dziubinski: Well, Christine, thank you for your time today and for helping us think about how we might customize this Bucket portfolio approach to ourselves. We appreciate it.
Benz: Thank you so much, Susan.
Dziubinski: I'm Susan Dziubinski with Morningstar. Thank you for tuning in.
Learn more: The Bucket Investor's Guide to Setting Asset Allocation for Retirement