Thanks to the Federal Reserve’s dramatic action in response to the COVID-19 crisis, yields have been pushed down across the board. That means that today’s retirees may still have a tough time subsisting on yield alone. Some income-focused investors have ventured further onto the risk spectrum to generate a livable yield; a smaller segment has been sticking with safer sources of income but trying to make do on less.
The Bucket approach to generating living expenses from a portfolio during retirement aims to meet those challenges head on. The basic strategy is that a retiree holds the bulk of her assets in a long-term portfolio that's diversified between stocks and bonds. She then augments it with a cash bucket that she uses for spending money and periodically refills that cash Bucket with income distributions, rebalancing proceeds, or both.
This Aggressive Bucket Portfolio is composed of traditional mutual funds. With a roughly 50% equity position and the remainder in cash and bonds, the portfolio is more stock-heavy than other in-retirement portfolios. It's geared toward younger retirees who are comfortable with the higher volatility that accompanies an equity-heavy mix.
Bucket Basics The central idea of the Bucket strategy, as envisioned by financial-planning guru Harold Evensky, is to include a cash Bucket to cover near-term cash needs. Over time, the cash Bucket will weigh on the portfolio's performance, as longer-term assets (stocks and bonds) will tend to generate better returns. The big benefit of the cash cushion, however, is that it provides peace of mind for a retiree to know that assets for pending expenses are safely segregated from the more volatile assets in the portfolio. Even in a scenario in which the stock portion of the portfolio dropped precipitously, the retiree could spend the cash in Bucket 1 and even move into the portfolio's next-line reserves--short-term bonds--without having to sell any stocks at a low ebb. If stocks go down and stay down for even longer, the retiree would have roughly 10 years' worth of living expenses in cash and bonds to "spend through" before needing to touch equities.
This particular portfolio is geared toward retirees who expect to live 25 or more years in retirement. As with all of my portfolios, its goal isn't to generate the best returns of any retirement portfolio on record, but rather to help retirees and pre-retirees visualize what a long-term, strategic total-return portfolio would look like. Thus, a newly retired investor could follow the basic Bucket concept without completely upending existing favorite holdings.
The portfolio includes three Buckets geared toward the near, intermediate, and long term.
Bucket 1: Years 1-2
- 8%: Cash (certificates of deposit, money market accounts, and so on)
The goal of this portion of the portfolio is to provide money for cash needs in years one and two of retirement, so we're not taking any risks with it. The yields on true cash instruments are currently comparable with those of short-term investments that don't ensure principal stability, so there's no sense in going with something that's not FDIC-insured.
An investor's own cash Bucket, and in turn the allocations to the other two Buckets, will depend on his or her portfolio spending rate. If an investor is using a lower starting withdrawal rate--say, 3% in the first years of retirement--bucket 1 would accordingly be smaller.
Bucket 2: Years 3-10
- 8%: Fidelity Short-Term Bond FSHBX
- 10%: Harbor Bond HABDX
- 7%: Vanguard Short-Term Inflation-Protected Securities VTAPX
- 10%: Vanguard Wellesley Income VWIAX
This portion of the portfolio is designed to deliver slightly more income than Bucket 1, as well as a dash of inflation protection and capital appreciation. The Fidelity Short-Term Bond fund is there if, in a worst-case scenario, Bucket 1 were depleted and rebalancing proceeds and/or income from the portfolio were insufficient to meet living expenses.
The linchpin bond holding, Harbor Bond, is an intermediate-term core-plus fund. As such, it may experience a bit more volatility than the short-term funds in bucket 2. PIMCO, which manages the fund, has historically done a good job of managing those risk exposures, however. And over time, the fund's slightly higher risk level should translate into somewhat higher returns than its short-term counterparts are able to earn. (That return pickup is relative, however, as today's yields are almost universally low.)
Because this portion of the portfolio has a longer time horizon but is focused on fixed-income investments, inflation is more of a concern. Thus, I've included a fund that invests in Treasury Inflation-Protected Securities, which adjust their principal values upward to keep pace with the Consumer Price Index. The short-term Vanguard fund delivers the desired inflation protection without the extreme rate sensitivity that accompanies longer-duration TIPS.
Bucket 3: Years 11 and Beyond
- 10%: Vanguard Total Stock Market Index VTSAX
- 24%: Vanguard Dividend Appreciation VDADX
- 15%: American Funds International Growth and Income IGIFX
- 8%: Loomis Sayles Bond LSBDX
Due to an anchor position in Vanguard Dividend Appreciation, which focuses on companies with a history of growing their dividends, the portfolio has a high-quality tilt that's appropriate for a retirement portfolio. A smaller position in Vanguard Total Stock Market supplies exposure to sectors that tend to be underweight in the Vanguard fund, such as technology.
American Funds International Growth and Income supplies international exposure. While its sizable emerging markets stake has the potential to add volatility, it maintains a sensible focus on dividend payers overseas, employs a multimanager setup that should help ease manager transitions, and charges a reasonable expense ratio. The F-1 share class is available on a no-load, no-transaction-fee basis via brokerage platforms like Schwab’s.
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.