The first quarter of 2020 provided an extreme stress test for all investors, but especially for retirees who are actively drawing upon their portfolios for living expenses.
High-quality bonds rallied but yields slid, further constraining the prospects for future bond-market returns. And while stocks made up a lot of ground in the second quarter, they experienced a searing bear market in February and March. The S&P 500 shed almost 20% of its value as news of the pandemic and its related economic effects began to sink in.
My Bucket Portfolios include a built-in stabilizer for turbulent times--cash reserves that retirees can draw upon when yields are insufficient to meet living expenses and it's not a good time to disturb stocks. The goal of having buffers like these is in no small part peace of mind: A retiree shouldn't be overly rattled during periods of short-term market turbulence because near-term spending will be relatively undisturbed and the rest of the portfolio can recover when the market eventually does.
Nonetheless, a tumultuous period like the first half 2020 provides a good opportunity to check up on the Bucket Portfolios. What helped, what hindered, and did the portfolios deliver on what they set out do?
Bucket Strategy Overview In each of my Model Bucket Portfolios, I've included three buckets that are invested based on the withdrawal horizon in a worst-case scenario. Bucket 1 holds the aforementioned cash for near-term portfolio withdrawals--anywhere from six months' to two years' worth of portfolio withdrawals. Meanwhile, Bucket 2 consists primarily of bonds (amounting to eight years' worth of portfolio withdrawals), which offer higher long-term returns than cash with much lower volatility than stocks. Bucket 3 is the longest-term component of the portfolio, offering higher long-term return potential than Buckets 1 or 2 but with substantially higher expected volatility.
Note that these portfolios are designed to be customized based on a retiree's own expected portfolio withdrawals. For example, a retiree who's withdrawing $30,000 per year from his or her portfolio would earmark anywhere from $15,000 to $60,000 in cash (six months' to two years' worth of withdrawals), another $240,000 in bonds (eight years' worth of withdrawals), and the remainder in stocks.
Mutual Fund Bucket Portfolio Performance
Performance Recap (Year to date through June 30, 2020) Aggressive Mutual Fund Bucket Portfolio: -3.12% Moderate Mutual Fund Bucket Portfolio: -1.91% Conservative Mutual Fund Bucket Portfolio: -0.90%
All three of the Bucket Portfolios composed of traditional mutual funds posted small losses in the first six months of 2020. Not surprisingly, given that stocks haven't fully recovered from the first-quarter market shock, the equity-heavy Aggressive portfolio had the biggest loss, slightly over 3%. Meanwhile, the more bond- and cash-heavy Conservative portfolio performed better, limiting its losses to just 0.90%. The Moderate portfolio's performance fell between the two.
Best Performers In keeping with their reputation as ballast for equities and other more volatile holdings, high-quality bonds have generally reigned thus far in 2020 and contributed the portfolio's best gains. Harbor Bond HABDX, an intermediate-term "core-plus" fund that serves as the linchpin fixed-income holding all three of the portfolios, made the biggest contribution to the portfolios during the first half. While some of its core-plus peers were harmed by overly risky positioning, the fund benefited from management's decision to peel back credit risk and maintain a slightly longer duration than its benchmark. Fidelity Short-Term Bond FSHBX also performed in line with my expectations that it would hold up well on the downside: While it has given up ground recently, as riskier bond strategies have prevailed, its conservative positioning held it in good stead during the first-quarter turbulence. I think of short-term bonds as "next-line reserves" in a worst-case scenario in which cash is depleted and a retiree needs additional funds, so a less risky short-term fund works well here.
Worst Performers Foreign-stock exposure didn't do the Bucket Portfolios any favors in the year's first half: American Funds International Growth and Income IGIFX posted the biggest loss of any holding in the portfolio, dropping about 14% and landing in its Morningstar Category's bottom quartile during the first half. A modest tilt toward value--including small overweights in the hard-hit energy and financials sectors--hasn't helped. Separately, that fund also saw the departure of long-tenured manager Mark Denning late last year, which senior analyst Gregg Wolper discusses in his most recent analyst report. The fund's rating remains at Gold, however.
In addition, the low-quality bond holdings were also on the laggard's list. Fidelity Floating Rate High Income FFRHX, which focuses on floating-rate investments, and multisector bond fund Loomis Sayles Bond LSBDX lost close to 6% apiece in the first half. Somewhat surprisingly, they even underperformed the domestic-equity holdings in the portfolios.
ETF Bucket Portfolios
Performance Recap (Year to date through June 30, 2020) Aggressive ETF Bucket Portfolio: -2.46% Moderate ETF Bucket Portfolio: -1.75% Conservative ETF Bucket Portfolio: -0.40%
All of the ETF Bucket Portfolios experienced small losses in 2020's first half. As with the mutual fund portfolios, the Conservative ETF portfolio held its ground better than its Aggressive and Moderate counterparts.
Interestingly, the ETF portfolios performed better than their mutual fund counterparts--for example, the Aggressive ETF portfolio lost less than the Aggressive mutual fund portfolio, and so on. That owes to a few factors. One is that Vanguard FTSE All-World ex-US ETF VEU lost substantially less than the active foreign-stock fund--American Funds International Growth and Income--found in the mutual fund portfolios. In addition, the junkier, noncore fixed-income holdings in this portfolio--iShares J.P. Morgan USD Emerging Markets Bond ETF EMB and Vanguard High-Yield Corporate VWEAX--generally lost less than their analog in the mutual fund portfolios, Loomis Sayles Bond.
Best Performers As with the mutual fund portfolios, the ETF portfolios' high-quality bond funds contributed the most to performance during the year's first half. Vanguard Short-Term Bond ETF BSV notched an especially impressive gain: In the risk-off market environment that was the first quarter, its high overall credit quality was a boon. The core fixed-income holding in these portfolios, iShares Core Total USD Bond Market ETF IUSB, posted solid gains, too. But owing in part to its exposure to lower-quality credits, it underperformed Harbor Bond, its counterpart in the mutual fund portfolio.
Worst Performers As with the mutual fund portfolios, foreign-stock exposure was a drag on returns in the ETF portfolios as well: Vanguard FTSE All-World ex-US was the worst performer in all of the portfolios in the first half. Those losses were especially impactful in the Aggressive portfolio where it takes up 15% of assets.
It's also worth noting that the core equity holding in the mutual fund and ETF portfolios--Vanguard Dividend Appreciation VIG--didn't distinguish itself relative to a broad market index in the year's first half. While it held its ground in the first quarter--and indeed performed better than the total market index fund that's also in the Aggressive and Moderate portfolios--it has struggled recently, as a handful of technology names that it doesn't own have paced the market.