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I’m always on the hunt for investment strategies that work for real people. So when financial planning guru Harold Evenksy mentioned his practice’s experience with the bucket approach to me more than a decade ago, it piqued my interest.
Simply holding a bucket of cash alongside his clients’ long-term portfolios, he explained, helped give his clients the peace of mind to stay the course during difficult market environments for stocks and bonds.
Based on feedback I’ve been receiving from readers since the current market sell-off began, employing a bucket strategy has provided many of you with exactly that feeling--that your retirement plans are under control even when everything else seems out of control.
Back in March, after the worst of the market rout had calmed down a bit, I conducted a review of how my Model Bucket Portfolios behaved during this unprecedented time. I had conducted previous "stress tests" of the bucket strategy to assess how it would have held up in the early 2000s' tech-led sell-off as well as the financial crisis. But the recent market shock provided a real-time view of how the strategy would behave.
The good news, as I wrote last month, is that the Bucket approach generally delivered, just as I would have expected it to. Cash, of course, held its ground, so Bucket 1 clearly proved its mettle. And Bucket 2 managed to escape with fairly minor losses as well, provided that investors concentrated most of their Bucket 2 assets in high-quality bonds. Stocks fell, but Vanguard Dividend Appreciation VDADX, which I’ve used as the linchpin equity holding, lost less than the broad market. That was what I had hoped its high-quality portfolio would be able to do.
Yet even as the portfolios’ performance was largely in line with my expectations, there were at least a few surprising developments for the portfolios. Four of the five surprises relate to cash and bonds--the “boring” parts of the portfolios--a somewhat surprising development in and of itself.
Surprise 1: High-Yield Savings Account Yields Have Stayed Strong Bucket 1--cash--is by no means a return engine, which is why I always urge investors to not overallocate to it if they're putting together their own bucket portfolios. A key development that has surprised me over the past few months, however, is just how decent the yields remain on many high-yield savings accounts, despite the Fed's lowering of its target interest rate to 0-0.25%. Today, you can find FDIC-insured online savings accounts with yields of 1.5% to 1.7%. That's higher than what money market mutual funds, which aren't FDIC-insured, are paying today and is even higher than the yields on many short-term bond funds. Of course, it's anyone's guess whether the online banks will be able to continue to offer such attractive yields. But for now the opportunity cost of overallocating to cash, especially a high-yield savings account, versus bonds seems quite low.
Surprise 2: Floating-Rate Performance Was Worse Than I Would've Expected In the category of negative surprises, the losses experienced by floating-rate funds, often called bank-loan funds, caught me off guard. Fidelity Floating Rate High Income FFRHX, a small position in the Conservative and Moderate Bucket mutual fund and exchange-trade fund portfolios, lost about 22% from Feb. 19 to March 23. That was worse than the losses experienced by Vanguard High Yield Corporate VWEHX and Loomis Sayles Bond LSBDX, two of the other lower-quality positions in the portfolios. Those funds lost 20% and 16%, respectively, from Feb. 19 through March 23. (Loomis Sayles Bond appears in Bucket 3 of the mutual fund Bucket portfolios, and Vanguard High Yield is in Bucket 3 of the ETF Bucket portfolios.) Of course, floating-rate investments should never be considered low-risk or economically insensitive: The loans that populate most bank-loan portfolios have been extended to lower-quality borrowers, some of which are distressed and/or operate in cyclical industries. But bank loans are higher in the capital structure than high-yield bonds, so I would've expected bear-market performance to be a bit better during this period than was actually the case.
Surprise 3: Munis Were Worse Than Expected, Too Also in the category of negative surprises, I was caught off guard by the selling pressure in municipal bonds, which appear in the Tax-Efficient Bucket portfolios, relative to taxable bonds during the recent market shock. From Feb. 19 through March 23, Fidelity Intermediate Municipal Income FLTMX and Fidelity Limited-Term Municipal Income FSTFX lost 9% and 6%, respectively. By contrast, the Bloomberg Barclays U.S. Aggregate Bond Index lost 1% over that stretch, and taxable short-term bond-index funds managed small gains.
In hindsight, the sell-off in municipal bonds makes sense: With economic growth constrained, many municipalities' tax revenues will be dramatically curtailed as well. Moreover, some municipalities are shouldering extra costs related to the current pandemic. Perhaps most important of all, muni yields were ultra-low coming into the crisis, giving bondholders little margin for error. But the fact that munis also experienced reliability problems in 2008 underscores the virtue of diversifying with other fixed-income assets, even for investors in high tax brackets. Treasury yields are ridiculously low today, but Treasuries have been better ballast for equities.
Surprise 4: Bifurcation Between Treasuries and Everything Else Was Large Relatedly, I was surprised at the performance gulf between Treasuries and almost everything else during the recent market shock, which featured a flight to cash and to the safe haven of Treasuries. Intermediate-term Treasuries gained about 5% from late February through late March, while long-term Treasuries gained a whopping 12%. Amid that flight to quality, the less-Treasury-heavy funds in my Core Bucket portfolios performed poorly by comparison: iShares Core Total USD Bond Market IUSB lost 3.3% and Harbor Bond HABDX lost 3.1% from Feb. 19 to March 23. I still like the extra flexibility, diversification, and yield pickup that comes along with these core-plus products, but Treasuries have shown yet again their value as equity diversifiers.
Surprise 5: Foreign Stocks Stayed Even With U.S. Finally, in the category of happy(ish) surprises, the fact that foreign stocks managed to stay even with U.S. during the worst of the market turbulence was a welcome development. In other market shocks, such as 2008's, foreign stock losses were greater than U.S. stocks. Of course, foreign stock funds have still generally underperformed U.S. for the year to date. But they also appear to have greater upside potential than U.S. today, based on my recent roundup of forecasts from market experts. Lower valuations and higher dividend yields likely cushioned the blow for foreign stocks during the recent market weakness and could give them an edge over the U.S. in the years ahead, too.