In the decade leading up to 2022, I often found myself on defense with respect to the Bucket approach to retirement portfolio management. The cash bucket exacted too big of an opportunity cost, the critics said. The strategy was nothing more than a gimmick, a form of mental accounting.
Enter 2022’s challenging market environment, however, and the Bucket strategy is doing exactly what it’s supposed to do. True, all of my Model Bucket Portfolios have lost money this year, and my guess is that most retiree bucketers are seeing red ink for the whole of their portfolios, too. (As of late June, a 60% U.S. equity/40% bond portfolio would be down about 16% for the year to date.) But the Bucket system has delivered by keeping the faucets open: Retirees using a Bucket system can draw upon their cash reserves without having to disrupt their long-term investments, which have likely experienced price declines so far this year. Retiree bucketers have been writing to me recently, noting that the strategy has provided them with their cash flow needs as well as a lot of peace of mind through this turbulent period. And that’s what it’s all about—crafting a plan that you can stick with through lean times like the present.
Yet as resilient as the Bucket strategy has been, I also find myself thinking about the famous line in the movie Jaws—"You're going to need a bigger boat." But in this case, the line could be, "You're going to need a bigger bucket." If retirees are plowing through their cash reserves (Bucket 1) for spending money, how should they plan to refill Bucket 1 if bonds and stocks stay down? Short-term bonds can serve as next-line reserves, and retirees using a Bucket strategy may also want to look for what retirement researcher Wade Pfau has called buffer assets—life insurance cash values, reverse mortgages, and possibly even annuities.
Here's a recap of how my baseline bucket portfolios have performed so far this year and what retirees should be thinking about with respect to bucket maintenance if the long-term components of their portfolios continue to struggle.
Performance Recap: Mutual Fund Portfolios
Aggressive Mutual Fund YTD Performance: -11.73%
8%: Cash 8%: Fidelity Short-Term Bond FSHBX 10%: Harbor Core Plus HABDX 7%: Vanguard Short-Term Inflation-Protected Securities Index VTAPX 10%: Vanguard Wellesley Income VWIAX 10%: Vanguard Total Stock Market Index VTSAX 24%: Vanguard Dividend Appreciation Index VDADX 15%: American Funds International Growth and Income IGIFX 8%: Loomis Sayles Bond LSBDX
Moderate Mutual Fund
YTD Performance: -10.19%
10%: Cash 10%: Fidelity Short-Term Bond 5%: Fidelity Floating Rate High Income FFRHX 15%: Harbor Core Plus 10%: Vanguard Short-Term Inflation-Protected Securities Index 5%: Vanguard Wellesley Income 10%: Vanguard Total Stock Market Index 20%: Vanguard Dividend Appreciation Index 10%: American Funds International Growth and Income 5%: Loomis Sayles Bond
Conservative Mutual Fund
YTD Performance: -8.60%
12%: Cash 12%: Fidelity Short-Term Bond 5%: Fidelity Floating Rate High Income 20%: Harbor Core Plus 11%: Vanguard Short-Term Inflation-Protected Securities Index 5%: Vanguard Wellesley Income 23%: Vanguard Dividend Appreciation Index 7%: American Funds International Growth and Income 5%: Loomis Sayles Bond
Not surprisingly, the stock-heavy Aggressive bucket portfolio has recorded the biggest losses so far this year, while the Conservative portfolio has held up the best and the Moderate portfolio’s results fall in between the two. Cash has provided a buffer for all three portfolios, as has the diversification within their fixed-income allocations—specifically, their exposure to shorter-duration fixed-income investments. Holdings in Fidelity Short-Term Bond, Vanguard Short-Term Inflation-Protected Securities, and Fidelity Floating Rate High Income have all held up substantially better than the broad bond market so far in this rising-rate environment.
Diversification within the portfolios’ equity allocations has also worked to their favor so far this year. One of the key reasons I’ve used Vanguard Dividend Appreciation as a core equity holding in all three portfolios has been to supply higher-quality, lower-volatility equity exposure, even if the trade-off is that it doesn’t always rack up the highest returns during rallies. Vanguard Dividend Appreciation has delivered on that thesis so far this year, losing about 5 percentage points less than total market index for the year to date through late June. (Of course, it also lagged the market from 2019-21.) Vanguard Wellesley Income, which stakes less than 40% of its portfolio in stocks and the remainder in bonds, has also held its ground: Its 10% loss for the year to date through late June is less than the losses incurred by the Bloomberg U.S. Aggregate Bond Index over that stretch.
Performance Recap: ETF Portfolios
Aggressive ETF YTD Performance: -12.03%
8%: Cash 7%: Vanguard Short-Term Bond ETF BSV 10%: Vanguard Short-Term Inflation-Protected Securities ETF VTIP 13%: iShares Core Total USD Bond Market ETF IUSB 28%: Vanguard Dividend Appreciation 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 J.P. Morgan USD Emerging Markets Bond ETF EMB
Moderate ETF YTD Performance: -10.17%
10%: Cash 7.5%: Vanguard Short-Term Bond ETF 12.5%: Vanguard Short-Term Inflation-Protected Securities ETF 7.5%: Fidelity Floating Rate High Income 15%: iShares Core Total USD Bond Market ETF 22.5%: Vanguard Dividend Appreciation ETF 10%: Vanguard Total Stock Market ETF 10%: Vanguard FTSE All-World ex-US ETF 2.5%: Vanguard High-Yield Corporate 2.5%: iShares J.P. Morgan USD Emerging Markets Bond ETF
Conservative ETF YTD Performance: -8.21%
12%: Cash 13%: Vanguard Short-Term Bond ETF 15%: Vanguard Short-Term Inflation-Protected Securities ETF 20%: iShares Core Total USD Bond Market ETF 6%: Fidelity Floating Rate High Income 21%: Vanguard Dividend Appreciation ETF 7%: Vanguard FTSE All-World ex-US ETF 3%: Vanguard High-Yield Corporate 3%: iShares J.P. Morgan USD Emerging Markets Bond ETF
My model ETF portfolios feature asset-class and investment-style exposures that are similar to the mutual portfolios, so their performance has been closely aligned with their mutual fund counterparts, too. Cash and short-term bonds have helped curb losses from the equity and longer-term bond holdings. And as with the mutual fund portfolios, the ETF portfolios’ stake in Vanguard Dividend Appreciation has helped trim their losses relative to the broad U.S. equity market.
What’s Next: Refilling Bucket 1
What about bucket maintenance during a down market like the current one? If retirees are using cash on an ongoing basis, how should they refill their cash bucket (Bucket 1) as it has been depleted? From 2019-21, retirees using a Bucket strategy would have been able to rely on appreciated equity assets to “refill” their cash bucket as they spent from it. The year 2022—like 2018—is shaping up differently. While we’re only halfway through the year, both equities and bonds could end the year in the red.
Spending the portfolio's organically generated income—from bonds and dividend-paying stocks—rather than reinvesting it is a start. And the silver lining of rising interest rates is that bond and cash yields have recently jumped up a bit. Additionally, my Bucket portfolios include roughly two years’ worth of portfolio withdrawals in cash to help provide cash flows in periods of sustained market weakness.
But what if stocks and bonds stay in the dumps for longer than two years, or if a retiree were employing a smaller cash cushion than two years’ worth of portfolio withdrawals?
In that case, retirees have a couple of options. One is to look to the portfolio for the least-bad option for withdrawals, which today is short-term bonds. My Model Bucket Portfolios include an allocation to nominal short-term bond funds (Fidelity Short-Term Bond in the mutual fund portfolios and Vanguard Short-Term Bond Index in the ETF versions) as well as short-term inflation-protected bonds (Vanguard Short-Term Inflation-Protected Securities in all of the portfolios). These holdings have posted small losses so far this year, but they’re decent next-line reserves to be tapped if true cash investments have been depleted. They’re not a cash substitute, but over market history, their losing periods have tended to be both shallow and short-lived.
Alternatively, retirees could look to nonportfolio sources for income—life insurance cash values, a standby reverse mortgage, or possibly even an annuity. (Of course, retirees running short on liquid reserves likely wouldn't have assets at the ready to purchase an annuity.) Retirement planning expert Wade Pfau calls these buffer assets and has suggested that they can help reduce a retiree's reliance on cash investments and, in turn, lift a portfolio's long-term return potential.