Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. We've talked a lot about the Bucket approach to retirement investing. I'm here with Christine Benz, she is our director of personal finance, to talk about how many buckets retirees really need.
Christine, thanks for joining me.
Christine Benz: Jeremy, great to be here.
Glaser: Let's start with just definitions about what this approach is. How would you describe it to someone who is not familiar?
Benz: I sometimes see the Bucket approach referred to as a time segmentation approach, and I think that's a nice way of putting it. The basic idea is that you are thinking about your spending horizon from your portfolio and using that to structure the portfolio. For assets that I'm going to need to spend right away, I want to keep that money very safe. I'd keep six months' to two years' worth of my portfolio expenditures in cash. From there I can step out on the risk spectrum. If I have a time horizon of, say, three to eight or three to 10 years, I can take a little bit more risk with that portion of the portfolio in the hope of earning higher return, and I can venture into bonds, maybe focus on high-quality short and intermediate-term bonds.
If I have a very long-term spending horizon for a component of my portfolio, I can think about venturing into higher-returning assets that have this potential for significant volatility along the way. I wouldn't want to earmark them for near-term spending, but if my time horizon is longer, like eight or 10 years, I can afford to be in the higher-growth investments.
Glaser: You've described three buckets there. But what if you wanted to simplify and go to two buckets? Is that something that's feasible?
Benz: Well, the person who really influenced my thinking in terms of this Bucket approach is Harold Evensky, the great financial planner. He talked about simply bolting on a cash bucket alongside the total return portfolios that he maintains for his clients. There certainly is a benefit of simplicity of saying, this is my intermediate and long-term, all-in-one component to my portfolio, and the rest is very near-term reserves. That makes a lot of sense.
The downside potentially, and the reason I have typically structured my model portfolios in terms of three buckets is that if you are using rebalancing to help meet your cash flow needs and to help refill Bucket 1 as it becomes depleted as you spend through your cash, well, the advantage of having discrete bond and stock holdings is that you can really see where do I need to go if I need to replenish that Bucket 1. In a year like 2017, for example, the answer is probably pretty obvious; it's that third bucket, the equity bucket, because stocks performed so well. In other years, maybe the bond piece will be the piece that grows, and you'd want to leave stocks alone.
Glaser: Let's talk a little bit about making extra buckets, adding buckets to the strategy. Is there ever a situation in which that would make sense?
Benz: I have heard from some of our Morningstar.com readers who have implemented a Bucket approach in their own in-retirement portfolio strategy. They have talked about a couple of ideas that I think are worth considering. One is simply having a separate emergency fund bucket where, just as they did while they were working, they are holding liquid reserves to meet expenses that arise apart from their anticipated spending. This might be car repairs or a new roof on the house or whatever it might be, they set aside a separate bucket to meet some of those unanticipated expenditures that inevitably arise in our lifetimes.
Another idea that I have heard from some of our users is having a fourth bucket, a very long-term bucket. Retirees have talked to me about using that bucket number four for a variety of different expenditures. Maybe it's someone who is planning to fund long-term care needs out of pocket. They want to segregate those assets from their spendable assets. They have maintained a separate account to meet potentially those unfunded long-term care expenses. Another idea would be for retirees who are very bequest-oriented. They know that they want to leave money behind for their children and grandchildren. They have segregated those assets from their spending assets. I think that those are some interesting ideas. If retirees have very long-term goals or desires for their money that aren't accounted for in their spendable portfolio.
Glaser: And from a practical standpoint, it's good to keep in mind that three buckets doesn't necessarily mean three accounts, that people's financial lives can be messier than that.
Benz: Absolutely. Unfortunately, it's more complicated than the simple three-bucket strategy that I've laid out in my articles on Morningstar.com, because in reality, many retirees will be bringing accounts with different tax characters into retirement. They might have the traditional tax-deferred accounts; they might have Roth accounts; they might have taxable accounts.
From a practical standpoint, it might be not quite as simple as having three accounts. They probably want to think about overlaying the Bucket approach over their different accounts. They'd also want to think about withdrawal sequencing when determining which types of assets to put in which account types. If they are using the standard withdrawal sequencing, they think about maybe making the taxable assets be a little more conservative; the tax-deferred assets potentially somewhere in between; if they have any Roth assets, which are usually the ones you'd want to save to later because they are most valuable to you from a tax standpoint, they'd want to think about making those more growth-oriented. Unfortunately, it's not quite as simple as I've made it look in some of my articles and in some of the model portfolios.
Glaser: Christine, thank you.
Benz: Thank you, Jeremy.
Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.