The Bucket Approach for Retirement Income

Christine Benz: Hi, I'm Christine Benz from Morningstar.com. I am here today with Harold Evensky. Harold is President of Evensky & Katz Wealth Management. Harold, thanks so much for being here.

Harold Evensky: Thank you.

Benz: Harold, you were really a pioneer in terms of what has now been called this bucketing concept for managing retirement income. Can you talk about the bucketing approach and why you think it makes sense for retirees who are managing their portfolios?

Evensky: The fact of the matter, it really makes sense for anyone. I think we believe that the risk of investing in the market is the short-term volatility of the market. So we developed back in the early '80s I think we call our five-year mantra; "five years, five years, five years," simply means we don't believe anyone should invest money that they are going to need in the next five years. Too much risk...

Benz: Stocks or bonds.

Evensky: Stocks or bonds, too much risk that they will need at the wrong time. So, we carve out for any lump sum, someone says, "Gee, I want to buy a second home three years from now," we will carve that out of the investment portfolio and put it in short-term bonds or cash. When it comes to retirement income, someone says, "Gee I got a million dollars, I need $50,000 year out." And trying to figure it out, carving five years' [worth] of cash flow is, there is too much opportunity cost, all that money sitting in cash, so we experimented and came up with two years. So I said, "OK, put two years in cash, take the other, the $900,000 and invest it in a total return portfolio."

What that does is you can take that cash and set it up to pay your check once a month like a payroll check. The market can be volatile, but you know where your grocery money is coming from, so you are not going to get panicked [about] what is going down. As you manage your investment portfolio, gets out of whack, you need to rebalance, you look over and say, "Gee, it's kind of down, let me move some money over."

So you can be much more cost and tax efficient in managing that portfolio. You are not going to have to sell at the wrong time. You can sleep through volatile times. As a client said, "to make sure I understand, I don't have to be happy but I don't have to worry."

No one is going to be happy losing money, but we did this prior to the '87 crash, clients came through well, tech bust and recently, so it is a very effective strategy of minimizing the risk of taking the money out at the wrong time. It's really a fairly simple idea.

Benz: Right. So now I think I have heard some advisors putting forth as many as eight separate buckets, how many buckets, so say you are a do-it-yourself investor managing your own retirement portfolio, what would be a sensible number of buckets?

Evensky: Basically two.

Benz: Two.

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Evensky: Keep the cash out, design the balance. You don't have time to kind of go into the multiple buckets, but the risk of a multiple bucket is you have one for college and you have got a goal before that that you want to take a trip, and you don't do it because you don't have enough money and then you find you have overfunded for the other one, you can't go back and take the trip later. So we believe that the overall planning ought to be holistic and the cash in the short term ought to be carved down. Plus for most people it is easy to understand the two buckets and manage those two.

Benz: You just have to be sure to periodically fill up that near-term bucket.

Evensky: Then you can consistently be reviewing, but if you have got an investment portfolio, there is always some reason you need to be making adjustments, rebalancing it, you fired a manager, you got some excess. So, say once a quarter, you just kind of look over and say, "Gee I am doing this anyway, let me take the opportunity to fill my bucket back on my cash bucket.

Benz: So within that longer-term total return bucket, you would presumably have a whole range of investment options ranging from quite conservative to your long-term stock holdings.

Evensky: Right. The allocation, the amount between bonds and stocks and aggressive a going to be a function of what do you need in terms of your returns long term to achieve your goals, that's going to determine that allocation. So that it may be very aggressive if you got lots of money; it may be very conservative, but that's unique to each individual.

Benz: Well, thanks Harold. That seems like a great approach that you were an early pioneer of and it is very intuitive and makes a lot of sense, so thanks for sharing it with us.

Evensky: Thank you.

Benz: Thanks for joining us. I am Christine Benz for Morningstar.com.