Retirement 'Bucket' Portfolios for Vanguard Investors
Designed for retirees in tax-deferred accounts, these portfolios blend index and active funds.
Readers responded to my recent series of Fidelity bucket portfolios with comments, emails, and even a few tweets. A recurrent theme? Can we get the same thing for Vanguard funds?
As it turns out, creating in-retirement model portfolios consisting exclusively of Vanguard funds isn't a heavy lift. Because of their ultralow costs and broad diversification, various Vanguard funds featured heavily in my previous model bucket portfolios, both the original series as well as the ETF and tax-efficient series that came later.
However, Vanguard doesn't field funds in some of the categories that appeared in my original portfolios, such as multisector bond or commodities. Moreover, the firm offers some stellar actively managed funds while also fielding a lineup of ultra-low-cost index funds, raising the question of whether and how to balance the two.
Ultimately, I decided to use a few more active funds than many index true believers might appreciate, especially with the equity piece of the portfolio. In part, that's because these portfolios are designed for tax-deferred accounts, so managing for tax efficiency--a big benefit of equity index funds and ETFs--is not valuable here. However, index enthusiasts could easily mirror the portfolio's asset-class exposures using all index funds or ETFs. (Retired investors in search of extreme simplicity could even use a cash component--bucket one--alongside a "three-fund portfolio," as discussed here.)
For retirees who would like to simplify further still, It's also worth noting that Vanguard Managed Payout VPGDX provides a cash flow stream, much as bucket strategies are designed to do, but does so with a single vehicle composed of several funds. As I've said before, I'd like to see fund companies innovate with similar all-in-one payout-type funds; most "retirement income" funds are inadequate for retirees' needs, and the managed-payout setup is a sensible one.
The Why and How of Bucketing The bucket approach to retirement planning is straightforward and makes intuitive sense. The basic idea, as envisioned by financial-planning guru Harold Evensky, is that a retiree holds a cash component alongside a well-diversified, long-term portfolio consisting of stocks and bonds. Knowing that money for near-term spending needs (one to two years' worth of living expenses) is parked in cash helps the retiree cope with the fluctuations that will inevitably accompany the stock/bond portfolio.
As with the other model portfolios, I've used
to help guide the overarching asset allocations of these Vanguard portfolios. To populate them, I've relied heavily on
. I expect to make few changes to the portfolios on an ongoing basis. I'll make adjustments only if there's a meaningful negative development at one of the holdings. My strategy for maintaining these portfolios will be strategic and hands-off; toward the end of each year, I'll discuss the mechanics of refilling bucket one (cash).
It's also worth noting that these portfolios aren't designed to beat all other retirement portfolios, but rather to illustrate the logistics of extracting cash flow from a portfolio in the current era of very low yields. Nor should these portfolios be construed as a call to reinvent an already-existing portfolio: While all of the funds in the portfolios are topnotch, investors with worthwhile core holdings could readily implement a bucket strategy using many of their existing portfolio holdings. I've used the lowest-minimum share class in these portfolios, but investors who are eligible to buy a cheaper share class should certainly do so.
Aggressive Bucket Portfolio Anticipated Time Horizon: 25 or more years
Bucket 1: Years 1-2 8%: Cash (money market funds and accounts, CDs, checking and savings accounts, and so forth; specific percentages will vary based on the amount of assets and the retiree's spending rate)
This portion of the portfolio is here to supply living expenses on an ongoing basis. As such, we're not taking any chances with it but instead parking it in true cash instruments. The specific percentage of the portfolio that bucket one consumes will depend on both the retiree's portfolio size as well as his or her spending rate. For example, a retiree with a $500,000 portfolio who's spending $15,000 a year would park 6% of his or her portfolio in bucket one ($15,000 times two, divided by $500,000). The retiree spends out of bucket one, then refills it as it becomes depleted, as discussed here.
Bucket 2: Years 3-10
7%: Vanguard Short-Term Inflation-Protected Securities VTIPX
Whereas bucket one is all about safety and liquidity, bucket two steps out a bit on the risk spectrum. The aim is to deliver a bit more income than bucket one, and possibly some growth, too, but without excessive volatility. As with the other portfolios, I've organized this portfolio by risk level. Vanguard Short-Term Bond Index will likely have limited volatility, so it can serve as next-line reserves in case bucket one is depleted and the combination of income distributions and rebalancing proceeds is insufficient to refill bucket one. I've stayed plain-vanilla with the core fixed-income position, too, employing Vanguard Total Bond Market Index in that slot. Much has been made of the index's heavy exposure to government-backed bonds, and its yield is quite low, but the portfolio's high quality means that it will likely hold up well in an equity-market shock. Moving into the seventh year of a bull market for stocks, that's an underrated virtue. I've also employed Vanguard's relatively new short-term TIPS fund in this part of the portfolio; it's unlikely to be much of a return engine, but as a short-term vehicle, it's unlikely to be extremely sensitive to interest-rate changes. Finally, I've included a position in Vanguard Wellesley Income to provide exposure to dividend-paying stocks as well as varying bond types.
Bucket 3: Years 11 and Beyond
5%: Vanguard Precious Metals and Mining VGPMX
The growth engine of the portfolio, bucket three is dominated by equity funds. The linchpin equity position, as with my original bucket portfolios, is Vanguard Dividend Growth, an actively managed fund that emphasizes high-quality U.S. names with a history of growing their dividends. I've augmented it with smaller positions in total stock market index trackers--one U.S.-focused and the other foreign. Investors could reasonably use an all-index approach to the equity portion of the portfolio, however; such a strategy would reduce the portfolio's total cost load while also improving its tax efficiency.
I've used a small slice of Vanguard's high-yield fund for bucket three, too; because it will tend to move in sympathy with the equity market, it makes sense to have a good, long time horizon for this portion of the portfolio. Finally, I've carved out a small stake in the firm's precious-metals equity fund. Vanguard doesn't offer a commodities-tracking fund (in fact, the firm's managed-payout fund holds a non-Vanguard commodities fund), but Precious Metals and Mining should provide a measure of diversification as well as the potential for inflation protection. Simplifiers could reasonably omit the high-yield and precious-metals funds and steer that portion of the portfolio to the stock funds.
Moderate Bucket Portfolio Anticipated Time Horizon: 20 years This portfolio contains the same holdings as the aggressive Vanguard portfolio, differing only in its allocations to them. Because it's geared toward retirees with shorter time horizons, it includes larger positions in high-quality short- and intermediate-term bonds and smaller positions in equities.
Bucket 1: Years 1-2 10%: Cash (money market funds and accounts, CDs, checking and savings accounts, and so forth; specific percentages will vary based on the amount of assets and the retiree's spending rate)
Bucket 2: Years 3-10 10%: Vanguard Short-Term Bond Index 10%: Vanguard Short-Term Inflation-Protected Securities 20%: Vanguard Total Bond Market Index 5%: Vanguard Wellesley Income
Bucket 3: Years 11 and Beyond 19%: Vanguard Dividend Growth 8%: Vanguard Total Stock Market Index 8%: Vanguard FTSE All-World ex-US Index 5%: Vanguard High Yield Corporate Bond 5%: Vanguard Precious Metals and Minerals
Conservative Bucket Portfolio Anticipated Time Horizon: 15 years In contrast with the aggressive and moderate portfolios, both of which emphasize growth to varying extents, this portfolio is geared toward older retirees with shorter time horizons. As such, its focus is on preserving purchasing power and funding living expenses; capital appreciation is secondary. Because its growth prospects are relatively low, it would not be appropriate for younger retirees unless they are extremely risk-averse and--more importantly--have more than enough money to last throughout their retirement years.
Bucket 1: Years 1-2 12%: Cash (money market funds and accounts, CDs, checking and savings accounts, and so forth; specific percentages will vary based on the amount of assets and the retiree's spending rate)
Bucket 2: Years 3-10 13%: Vanguard Short-Term Bond Index 10%: Vanguard Short-Term Inflation-Protected Securities 20%: Vanguard Total Bond Market Index 5%: Vanguard Wellesley Income
Bucket 3: Years 11 and Beyond 20%: Vanguard Dividend Growth 8%: Vanguard Total Stock Market Index 7%: Vanguard FTSE All-World ex-US Index 5%: Vanguard Precious Metals and Minerals