Benz: Building Your Retirement Portfolio

[Music] hi and welcome back if you're just joining us I'm Christine Benz for morningstar.com all day today we've been talking about retirement readiness we just spent a few sessions talking about looking at your income needs in retirement looking at how much of those income needs will be supplied by certain sources of income and then we look a little bit at withdrawal rates in the preceding session now we're going to talk about how to structure your portfolio based on your anticipated spending needs from your portfolio before I get into this presentation I'll just note that you can go ahead and download slides we'll make them available after the presentation you can also submit questions and there are instructions below on how to do that my colleague Jeremy Glaser and I will be tackling some of your questions toward the end of this session let's get right into the presentation and talk about what we'll be discussing in the course of this presentation I'm going to spend some time providing an overview of the bucket approach what it is and why I think it's an intuitive way to think about organizing your in retirement portfolio I'll talk about how to employ a bucket approach with your own portfolio how to use your own spending needs to dictate how much you hold in each of the buckets I'll share some sample bucket portfolios for retirees with different income needs different time horizons different asset allocations I'll spend some time talking about how to maintain a bucket portfolio on an ongoing basis unfortunately even though the bucket strategy is a nice intuitive way to approach retirement portfolio planning it doesn't run itself you do need to do some ongoing maintenance I'll be sharing some do's and don'ts on that front and finally I'll spend some time toward the end of the presentation talking about my model bucket portfolios on morningstar.com I've created several different versions of these bucket portfolios I'll share some of them with you I'll share the thought process behind these model portfolios before I get into the bucket approach let's recap where we are today because you really need to run through this exercise in order to employ a bucket strategy for your own retirement portfolio so the first step in the process is to take stock of your total income needs in retirement what you think your spending will look like in retirement obviously if you're very close to retirement this is a lot easier to do than it then it's the case of retirement is further off into the future the next step in the process is to assess how much of those spending needs will come from non portfolio sources of income so here we're talking about Social Security perhaps pensions for some of you perhaps annuity income for others of you perhaps income from part-time work or income from rental properties if you own them the idea is to take stock of all of those non portfolio sources of income you then want to subtract those non portfolios sources of income from your spending needs and the amount that's left over is the amount that your portfolio will need to supply so you need to stress test that number make sure that it's a sustainable number and we talked about how to do that in the preceding session so let's take a look at an example we'll assume that we've got a 65 year old couple they've taken a look at their spending needs in retirement to determine that they need about a hundred thousand in income from all sources and they've determined that about $40,000 of those income needs will come from Social Security and a small pension so they're going to need their portfolio to step up and replace $60,000 of their income needs if they're looking at a sustainable withdrawal rate they'll want to make sure that their portfolio is at least one and a half million dollars that's the amount that they would need to have saved in order to support that $60,000 per year spending rate that 60,000 is a is 4% of 1.5 million so if their portfolio is lower they need to see if they can tweak the variables a little bit they need to at least think about delaying retirement or potentially reining in their spending so that their portfolio withdrawal rate is in the sustainable range now let's take a look at how you can use that spending rate to determine how you organize your portfolio and that's really the basic idea of the bucket approach to retirement portfolio planning you look at how much you'll need in the near term how much you'll need further out in retirement and you use that to right-size each of your bucket allocations so your near-term spending needs this is money that you expect to need in the next one to two years you don't want to jeopardize your near-term spending by investing in anything too risky you need to keep that money safe so in my bucket approach I've generally used very safe assets for bucket number one discovers one to two years worth of living expenses for bucket two we're stepping out a little bit on the risk spectrum this is money that in my bucket structure would cover roughly year three through ten of retirement because you have a longer time horizon for this portion of the portfolio you can afford to take a little bit more risk with it so here we're holding assets with a little bit of risk but not too much primarily high-quality bonds for your long term spending needs where you have a time horizon of ten years or more you can definitely afford to take more risk with that portion of the portfolio so you're investing primarily in stocks which are volatile in the short term but pretty reliable in the long term and generally outperform other asset classes over very long time horizons so that's the basic framework behind the bucket approach one caveat that I would point out though is that the bucket approach even though it's a nice intuitive way to approach portfolio planning it can't solve for a to high withdrawal rate or a to small portfolio you need to look to other levers to help address those issues but the bucket approach is a nice way to back into an appropriate asset allocation framework given your spending horizon assuming that that spending pattern is sustainable overall so in terms of the virtues of the bucket approach why I like it so much as a way to position a retirement portfolio as I mentioned it can help you back into an appropriate asset allocation I think a lot of times people look at asset allocation models and they might seem a little bit black box to your academic e the bucket approach can help you use your own spending needs to dictate how you allocate your assets across cash and bonds and stocks it also helps ensure that you don't have to sell any stocks during a trough to meet your living expenses the idea is that if you have enough assets in cash and in bonds that should tide you through rough periods for equities you can hold on to your equities let them grow let them recover from those inevitable inevitable periods of market weakness the bucket approach also enough enables you to take enough risks so that you can grow your portfolio over the long term but not enough to jeopardize your near-term standard of living another thing I like about the bucket strategy is that it enables you to psychologically endure those inevitable week periods for stocks if you know that your near-term and intermediate term income needs are set aside you can put up with the downturns that do a company stocks from time to time and another key thing I like about the bucket approach and one reason that I began to work on this approach in earnest for morningstar.com readers and viewers was it it D tethers you from whatever is going on with income at any given point in time so as many of you know if you are getting close to retirement or already retired we've seen yields go way way down and that has left retirees with the unfortunate choice of having to make do on less and less in income or to venture out on the risk spectrum in search of income the bucket strategy enables retirees to not focus so much on income but instead focus on building a total return portfolio with the best possible risk return profile for them and not worry so much about the current income that their portfolios are generating before I go any further I would say that we very much embed income producing securities within the context of these bucket portfolios but current income generation is not a key goal for these portfolios this is just a quick visual depicting the bucket approach in action you can see that in my bucket folios I've employed generally three buckets one for near-term living expenses I parked one to two years worth of assets of spending needs in bucket number one and we're not taking any risk with this portion of the portfolio this is primarily cash or entirely cash and here you're talking about CDs perhaps money market mutual funds or money market accounts right now online savings banks are some of your best sources of guaranteed yield we're not taking any risks with this portion of the portfolio though I sometimes get questions from retirees who say well what about bank loan funds or what about real estate investments you'd want to put them in your later buckets you don't want to jeopardize your near-term spending by venturing out on the risk spectrum with bucket number one bucket two as you can see edges a little bit out on the risk spectrum this is where I've parked assets for years three through ten of retirement in my bucket portfolios I've generally used high-quality short and intermediate term bonds for this portion of the portfolio I've also used a little bit of high-quality equity exposure you might think about using a balanced fund or some sort of conservative allocation fund for this portion of the portfolio and here I've earmarked the asset for years three through ten of retirement bucket three is the risk engine of the portfolio it's the return engine of the portfolio as well so it holds primarily equities it holds a globally diversified equity portfolio in my framework it will cover you for years eleven and beyond of your retirement so for new retirees you can see that if you're using a structure like this from a practical standpoint it would mean that they would probably have most of their assets in bucket three if they have a nice long time horizon through retirement for older retirees that would mean that they would have more of their assets in buckets one and buckets two perhaps their bucket three would be a little smaller so this is the general framework that I've used when structuring the various bucket portfolios that I've created for Morningstar com a logical question is how I decided which types of assets to put inside each of these buckets the short answer is that I use the probability of having a positive return within each of these time horizons to determine the asset class that I used so for a very near term income needs where we just have a one or two year time horizon as is the case for bucket one we can't take any risk with that portion of the portfolio at all so I've used to cash instruments because it's the only asset class where you can find a guaranteed rate of return granted it's a guaranteed low rate of return right now but nonetheless it's a guaranteed rate of return for bucket two because we have a time horizon of three years or longer we can afford to take a little bit more risk with this portion of the portfolio so bonds over any rolling three three year period that we look at have been extraordinary extraordinarily reliable certainly over the past twenty five years so within bucket - we do use high quality bonds because even though they may have periods of short-term losses they will generally be pretty reliable to hold their value over any three-year period bucket three is where we hold the growth producing assets stocks are way too volatile for bucket two certainly to be the core of bucket two but once you have a ten year time horizon or longer specs are actually quite reliable so when we look at rolling ten year periods for stocks what we see is that over various ten year rolling time horizons that stocks have actually been really reliable they've had positive returns about 90 percent of the time so if you have a time horizon of ten years or longer you should be primarily invested in stocks because of their higher return potential so let's run through some examples of how retirees can use their own situations and their own spending needs to determine how they employ these buckets so this baseline case here is Jack and Carol they are 65 year old new retirees both the same age and they are using a 4% withdrawal rate with that 3% annual inflation adjustment from their one and a half million dollar portfolio so they're taking a sixty thousand dollar annual withdrawal from their portfolio they'll nudge that withdrawal rate up a little bit as the years go by to account for inflation so they have a 25 year anticipated time horizon in retirement and they have a fairly aggressive risk tolerance to match so they're willing to hold at least 50% of their portfolio in stocks and they want to use the bucket approach to positioning their portfolio in terms of how that would translate into how they position their portfolio they would hold two years worth of living expenses so $60,000 times two in bucket one they're not messing around with this piece of portfolio they're holding true cash investments with this portion of the portfolio with bucket two they are taking a little bit more risk so they're marking enough cash flow for years three through ten of retirement so that's six sixty thousand times eight years four hundred eighty thousand and they're staging this portion of the portfolio by risk level this is kind of how I've thought about structuring my model bucket portfolios we're starting with very safe securities at the top of the portfolio so short term high quality bonds at the top followed by high quality intermediate term bonds followed by a little bit of a conservative allocation fund in this case so the idea of that structure of stair-stepping bucket to buy risk level is if in some sort of catastrophic scenario and they've spent through their bucket number one they don't have any more cash left because rebalancing proceeds or income from their portfolio was insufficient to meet their their income needs they can then turn to bucket two as next line reserves and they would probably draw from those high-quality short term instruments first so that's the basic structure of bucket two it takes a little bit more risk but not too much risk relative to bucket 1 and then bucket 3 this is the engine of the the portfolio this is loosely modeled on my model mutual fund bucket portfolios you can see that the bulk of this portfolio is in high-quality US equity exposure they do have some high-quality foreign stock exposure this is where I would also hold some higher risk fixed income types so to the extent that you want to hold say junk bonds or emerging markets bonds or in the case of my model portfolios some sort of a multi sector bond fund I would hold it here where I have a nice long time horizon the reason is that high yield or riskier bond types can periodically experience periods of extreme volatility so you want to make sure you have a nice long time horizon for them I've also made room for a little bit of commodities exposure in this portion of the portfolio this is kind of a controversial subject the idea is to provide a little bit of extra diversification because commodities are quite volatile as stand-alone investments I've kept the position in the portfolio quite small and I've also made sure to have a nice long time horizon for this portion of the portfolio if you wanted to make room for equity precious metals funds or say a real estate fund I would hold it in this portion of the portfolio the same would be true for any individual equity holdings I want to make sure that I had at least a 10-year time horizon for them so I would hold them in bucket number three you can see that in the case of this hypothetical couple this is the lion's share of their portfolio they had $600,000 of their portfolio allocated two buckets one and two but the bulk of their portfolio is in bucket three in part because they have such a nice long time horizon in retirement my next hypothetical case is IDI it is a bit older than the previous couple he's 85 years old he has a $300,000 portfolio he is spending about twenty five thousand dollars a year from the portfolio he anticipates that he has about a ten year time horizon to be spending from that portfolio that anticipated life expectancy he wants to use a bucket approach he likes exchange-traded funds and he has long-term care insurance just to simplify this example we'll assume that he doesn't have a long-term care need in reality this could be more complicated if he did not have such an such an insurance policy or even if he did but will just assume that the long-term care need is not part of his retirement portfolio plan so let's take a look at his bucket portfolio as I mentioned he has a 25 thousand dollar spending need from that portfolio multiplying that by two determines how much he should hold in bucket number one so he has about fifty thousand dollars earmarked and true cash investments then his bucket two is the rest of his portfolio because his time horizon is fairly short for his retirement portfolio he can't afford to take a lot of risk in stocks he can have a little bit of equity exposure but with a less than ten year time horizon or a roughly ten year time horizon he doesn't want to have too much part in stocks so the bulk of his bucket too is high-quality fixed income exposure short-term as well as intermediate term and we've also tacked on a little bit of high quality equity exposure the funds exchange-traded fund that I've used here is the anger dividend appreciation the ticker is Vig so Ed's portfolio doesn't include a bucket number three because he anticipates that his time horizon is roughly ten years so he can get it done with just two buckets Madeline is a different story she is a new retiree of 60-year old retiree this is not a common scenario where she has a lot of her income needs being met from a pension unfortunately it's a smaller and smaller segment of the population that is retiring with a pension but in Madeline's case we're assuming that she has a pension that's stepping up and providing most of her in retirement income needs so she's really just sipping from her portfolio she's spending just ten thousand dollars annually from her five South five hundred thousand dollar portfolio she anticipates that she'll have a roughly thirty year time horizon in retirement she wants to use the bucket approach and she has a high risk tolerance she knows that a lot of her income is going to be coming through the door through her pension so she's comfortable taking extra risk with her portfolio I'll just stop right there and say that Madeline's high risk tolerance may not fit everyone there may be retirees for whom even though stable sources of income are meeting a lot of their income needs they may just not be comfortable with the high volatility that can accompany a mostly equity portfolio in which case by all means they want to take more of their portfolios in safe securities but just for the purpose of illustration we're assuming that Madeleine has that high risk tolerance she can take more risk perhaps she wants to earmark and grow her assets her for her heirs or perhaps for charity so in Madeline's case were assuming that she has that liquidity portfolio and you can see because her spending demands from that portfolio are quite low she can afford to have just a little bit invested in bucket one she doesn't have to hold all that much in safe securities so she can just take her spending need times two or perhaps she'd want to enlarge it to accommodate emergency expenses or perhaps some trips that she'd like to take in the early years of her retirement but she doesn't need to stake too much in bucket one because so much of her spending needs are being met through that pension bucket two is also pretty small in Madeline's case so we're assuming that she has $80,000 in her bucket - she's holding primarily bonds in this portion of the portfolio or entirely bonds in this portion of the portfolio again high-quality short and intermediate term bonds in Madeline's case her bucket three is the bulk of her portfolio we talked about Edie not having a bucket three Madeline has a very large bucket three because she has such a long time horizon for the spending for that portion of her portfolio so she has her portfolio invested primarily in equities her bucket three is invested primarily in equities she has a high quality index fund Vanguard dividend depreciation as well as Vanguard total stock market index she holds a foreign stock fund as well as some junkier fixed end income exposure via Loomis Sayles bond as well as a dash of commodities exposure as was the case in our first illustration so you can see that in Madeline's case the bulk of her portfolio is staked in bucket three because of her limited spending needs from her portfolio so let's talk about bucket maintenance because as I mentioned at the top bucket portfolios don't maintain themselves you need to do a little bit of work to keep them up to date on an ongoing basis so the basic idea if you're using a bucket strategy is that you're going to spend from that bucket number one on an ongoing basis you're going to use your bucket number one to meet your spending needs but you periodically need to replenish it and that's where the maintenance piece of this comes in so for some retirees if they have income producing securities in their portfolio whether dividend paying stocks or bonds they can simply use those income distributions and plow them into bucket one on an ongoing basis they can periodically top-up their bucket number one in fact they can have those distributions automatically moved into bucket one they might also need additional income above and beyond what their portfolio is supplying organically though and so in that case they'd want to turn to rebalancing so in 2016 for example we saw a very strong market for this for the stock market a retiree who needed to rebalance to harvest some cash flow from his or her portfolio might have scaled back on stock to plow money into bucket one so the approach that I really favor is kind of a hybrid approach where you're seeing how far your income distributions can take you in terms of replenishing bucket number one and then you're periodically scaling back appreciated portions of your portfolio to meet additional income needs as you have them I think that that strategy can make a lot of sense for retirees what bucket maintenance doesn't mean is that you're not spending through the buckets sequentially so some some retirees might assume that when we talk about this three bucket strategy it means that you spend through bucket number one then move on to bucket number two you spend it all down then you move on to bucket number three and spend that that might seem like an intuitively appealing approach but the risk that it courts is that you would get to bucket three at a time when your equity portfolio your bucket three was in a little bit of a trough so you don't want to be in that position of having to invade your equity portfolio when it's down so that's not an approach to bucket maintenance that I would advise bucket maintenance also doesn't mean that you're constantly moving money from one bucket to the next so some retirees might assume that when we talk about this bucket strategy it means that we are constantly moving money from bucket three to two and two to one and that you're doing this all the time that's just too much work in retirement my thought is that you use the income distributions to see how far they'll get you in terms of replenishing your bucket number one if you need additional income from your portfolio or additional cash flow from your portfolio you'll then turn to rebalancing to help top up your bucket one further so let's take a look at how bucket maintenance would work in practice let's assume that we have a retiree who needs $40,000 in cash flow from his or her $1,000,000 portfolio and they needed to refill bucket one in 2016 so they've spent through what was in bucket one they want to replenish bucket one they want to top it back up so assuming that person had a 60% sp500 tracker with a portion of the portfolio and had a 50% bond portfolio that portfolio would have yielded about $21,000 a little bit more than $21,000 in 2016 so that's not quite there to $40,000 so they the retiree would need to get that addition eighteen nineteen thousand dollars from doing some rebalancing the portfolio the good news is that 2016 was a really good year for the equity markets as they just mentioned so that portfolio would have generated a capital return about a hundred and six thousand in 2016 so of the $40,000 in income needs in retirement about twenty one thousand of that would have come from the organically generated income return from that stock and bond portfolio and then the retiree would get the remaining eighteen nineteen thousand dollars from capital return from rebalancing the appreciated equity position the retiree could then reinvest the remaining capital return into depreciated parts of the portfolio so assuming a really simple portfolio you would reinvest in bonds assuming that that support that the portfolio consisted of just a u.s. equity and a fixed income piece in terms of my model bucket portfolios on Morningstar comm created a lot of different variations of these bucket portfolios I wanted to spend a little bit of time talking about what I was trying to achieve what I've been trying to achieve with these portfolios they're designed to depict what I think are sound asset allocation and portfolio maintenance practices for in retirement portfolios they're not designed to blow the doors off of any other retirement portfolio strategy ever designed so even though I think that they're sensibly created sensibly maintained they're not really gunning for the highest possible return they're just designed to depict what I think are sound portfolio management and maintenance practices on an ongoing basis to help structure the portfolios I've used Morningstar's lifetime allocation indexes to help structure the portfolios these are created by a team within Morningstar investment management there are indexes that you can take a look at they may or may not match your own situation but I think that they generally depict sound asset allocation principles I use a strategic approach to setting the portfolio's asset allocations that means that I'm not going to try to jockey around to capture the best possible return from any asset class at any given point in time generally going to just rebalance back to the target asset allocation on an ongoing basis I make changes only if the fundamentals of the portfolio's change so for example as long as I've been managing these portfolios we've had a fund closed Vanguard dividend growth I mentioned close to new investors we replaced it with Vanguard dividend depreciation we also look to the analyst ratings to help structure the portfolio's so initially with my baseline traditional mutual fund bucket portfolio I use t rowe Price short-term bond fund it's still a solid fund but it has been downgraded to a neutral rating I swapped in the silver rated fidelity short-term bond in its place so I use the analyst ratings to help light the way of how to position these portfolios I am assuming in the case of all of these portfolios that if you're using them that you use your own spending rate to right-size your allocations to each of these out asset classes so you'd start with your spending needs to structure how much to hold in bucket one and then you structure the other buckets of your portfolio accordingly let's take a closer look at my aggressive mutual fund bucket portfolio this is the first portfolio that I created for morningstar.com you can see that as we've talked about it includes the liquidity piece we're not taking any risk with this portion of the portfolio right now for most investors the best source of safe yield will be some sort of an online savings account where you may be able to earn a yield of say 1% on your money today this is a portion of the portfolio that may not outter an inflation over time which is why you don't want your bucket 1 to be too large you don't want to be thinking about holding anything like 5 years worth of living expenses in bucket 1 because you may actually lose money on an inflation adjusted basis over time so roughly eight percent of this portfolio is allocated to just to cash guaranteed FDIC guaranteed instruments the next portion of the portfolio bucket - is primarily high-quality fixed income exposure you can see that we've included some high quality short term exposure both fidelity short term bond as well as Vanguard short term inflation protected securities which invests in short term tips bonds here I've used harbor bond to be kind of the core fixed income piece investors who have other core fixed income holdings could use them in this context so perhaps you hold Vanguard total bond market or a fidelity total bond or dodge and Cox income or met West Total Return bond any of those core intermediate term bond funds could work well in this context but here I've used harbor bond which is a no load near clone of PIMCO Total Return I've also used a little bit of Vanguard Wellesley income in this portion of the portfolio this is a conservative allocation fund that has roughly 2/3 of its assets and fixed income investments and the rest in high quality income focused equities the bucket 3 of this portfolio is the growth engine of the portfolio earmarked for years 11 and beyond of retirement as I've done with all of the other samples that I've shown you I've elevated the lion's share of this portfolio to high-quality US equities I have included Vanguard dividend depreciation as a high-quality dividend focused offering I would take pains to point out that it doesn't have a yield that's high in absolute terms in fact it's yield is roughly in line with the broad markets but it is generally a higher-quality basket of stocks than you get with a total market index fund I've included harbor harbor international as my core international peace of this portfolio investors will want to think about holding roughly 25 to 30 percent of their total equity portfolio in some sort of a global or foreign stock Equity Fund I've also included a little bit of lower quality fixed-income exposure Loomis Sayles bond has been the fund that I've used here as well as a little bit of commodities exposure with this portion of the portfolio the moderate bucket portfolios I've created them in both traditional mutual fund as well as exchange-traded fund versions in the case of the ETF version which is featured here you can see that it has a little bit more in cash but again a retiree should use his or her own anticipated spending needs to right-size how much to hold in bucket one bucket two again is high-quality fixed income exposure largely and you can see that the complexion here of the etf only portfolio really mirrors what we had in the case of the traditional mutual fund portfolio so you have high quality fixed income exposure you also have a little bit of high-quality equity exposure at the tail end of this portion of the portfolio so here I've used Vanguard dividend depreciation in this case the exchange-traded fund versus the traditional mutual fund and then the growth piece of this portfolio it's a little smaller than was the case for the aggressive portfolio but it still has ample equity exposure so we've got sizable positions in Vanguard dividend depreciation as well as total stock market index we also have a total foreign stock market index fund that includes some emerging markets as well as mostly developed markets exposure we have a little bit of lower quality fixed income exposure with this portion of the portfolio so a little bit under junk bond fund a little bit in a local currency denominated emerging markets debt fund and here we're holding fairly small positions because as standalone investments these are pretty volatile investment types we've also got a nice long time horizon for them for them and finally we've got a little bit of commodities exposure for this portion of the portfolio as well I've also created some tax efficient bucket portfolios these are designed for the non retirement portion of your portfolio to the extent that you have taxable assets that's what these portfolios are designed to help you structure and so you can see that in the case of this conservative bucket portfolio I've used true cash investments for bucket one you might use some sort of municipal cash investment but right now yields are so low across the board and bucket two isn't large enough that it should matter a lot whether you use some sort of muni account or whether you use a taxable account but you can see that in bucket - I have prioritized municipal bond funds I've used Fidelity's funds for the bulk of these tax efficient mutual fund portfolios and I've used some short-term exposure as well as some intermediate term exposure for bucket three of these tax efficient portfolios I've used tax managed funds for the US equity piece you can certainly use some sort of a total US market index as well as a total foreign market index for this piece of the portfolio in fact I've used Vanguard footsie all World X US fund to be the foreign stock piece but the basic idea of using index funds or tax managed funds here is that they tend to limit taxable capital gains distributions so they tend to be nice tax efficient holdings for your taxable account so that's the basic idea behind these tax efficient bucket portfolios in addition to some of the bucket portfolios that we've just talked about I've also created bucket portfolios for people who choose to hold their assets with a single mutual fund family so I've created bucket portfolios for Vanguard fidelity t rowe price and Schwab investors so if you care to do your business with just one platform those portfolios can help you figure out what would be some reasonable holdings for your in retirement bucket portfolios I would take pains to say though that you should absolutely if you have holdings that you really like that you've lived with for many years that you should absolutely stick with them when structuring your own bucket portfolio bucket strategy is not meant as a call to upend what you've got chances are if you've got a well-diversified balanced portfolio you already have a lot of the building blocks that you need to create your own bucket portfolio now I'm just going to spend a little bit of time talking about some back tests that we've done on these model bucket portfolios they've only been around for a few years but we decided to look back in history to just take a look at well how did this bucket strategy do over some more punishing time horizons so I started this simulation of how the bucket strategy would have performed back in 2000 which is meant as many of you will remember was a difficult market for equity investors we had that big sell-off in growth-oriented equities a big market shock overall it would have been a tough time to retire so I made some assumptions about how the portfolios were being updated and maintained on an ongoing basis I've included them here I assume that that the retirees were taking a 4% initial withdrawal and giving that a little bit nudge up of a nudge up to account for inflation in each year I assume that the retirees were foregoing the inflation adjustment in years when the market was down and I assumed a pure Total Return approach so I assumed the retiree was relying exclusively on rebalancing proceeds to help top-up bucket one and the results when we looked back on how these portfolios would have behaved we're pretty encouraging so what we saw was that the bucket portfolios were able to meet that income need that we identified at the outset of the of the simulation so that was encouraging and the portfolio's at least at the end of 2015 were able to hold their ground nicely over that time period as well I would note a couple of things though before I get too carried away in terms of touting these returns so first I would say that this is a pretty favorable time period overall so even though it was punctuated with some difficult market environments notably tough market environment in 2003 2002 and then of course during the financial crisis what we have here is positive end date bias so it after the financial crisis as you all know we've experienced a very positive equity market environment so that arguably makes us look a little smarter than we are and another point I would make is that I compared this bucket strategy and the performance of a bucket portfolio versus a portfolio that didn't have that bucket number one that didn't have any dedicated cash investments and what I would say is that the bucket approach actually underperformed that fully invested portfolio so if we took the bucket 1 and invested it in stocks and bonds rather rather than holding cash aside what we saw was that the bucket approach actually underperformed that fully invested approach I think what that simulation doesn't capture though is the peace of mind that you get by knowing that you have your near-term income needs set aside and that's part of why I think the bucket strategy can be so appealing and now Jeremy Glaser's here we're going to tackle some of your questions which you've already submitted if you'd like to submit a question even still please use the instructions below to do so we look forward to tackling some of them Christy thanks for the presentation the first question is on if someone wanted to simplify the bucket strategy you know it's still too many holding still too much maintenance there's a way that you could even make this simpler if that's something that a user or an investor would want to do absolutely I think that's a really worthy goal and probably the best way to do that would be simply to think of your cash piece think of maybe some single high-quality bond fund I might I might add short term as well as an intermediate term fund so I might have a two parter there for bonds high-quality short-term high-quality intermediate term you could use index products there and then use total market index funds for both US stocks and foreign stocks and then I think you could call it a day and that would give you some discretion over where to go for living expenses as if you needed to refill that cash base and of course you'd want to hold cash too so I like that idea if you want to reduce the number of moving parts in your portfolio it's hard to go wrong with that low cost broadly diversified index fund or funds one question I sometimes get is how about a single fund a one fund solution to my Dee accumulation problems and I love single fund solutions for accumulators I think target-date funds for example are one of the great innovations from the financial services industry ever but I would say that when it comes to the accumulation ideally I think you would want to reserve the right if you're having to refill this cash bucket on an ongoing basis seems like you'd want to reserve the right to decide where you go for that cash on an ongoing basis so end of 2016 for example I don't want to pull proportionately from stocks and bonds as would be the case if I had some sort of an all-in-one fund I want to reserve the right to go right to my highly appreciated stocks leave my bonds alone maybe even add to my bonds and add to my cash holdings so that's I think one potential drawback when it comes to the accumulation and the single fund solution that you lose a little bit of that discretion over your cash flows it's possible to simplify ven but maybe not too much exactly we have a question that catches on something that we talked about earlier in the day about asset location when you think about the buckets are there different account types a Roth IRA or traditional IRA that you kind of have in mind for each bucket or is it going to depend on an individual situation it depends unfortunately I guess in a really simplified example let's say an investor came in and came into retirement and had his or her cash needs queued up as well as the bond needs and the long-term needs ideally you'd sort of think about as Maria and I talked about in an earlier session you think about pulling your more liquid assets or parking your more liquid assets in the taxable accounts and then perhaps moving on to tax deferred accounts so maybe that bucket to to the extent that you have a bucket - you'd want to have that in your text deferred accounts and then the Roth accounts kind of the growth engine of your portfolio I guess that's where you want to think about having the high-growth equity assets but many people as Maria said are coming into retirement with portfolios that are very tilted toward traditional tax deferred accounts so for them most of their portfolio would be in in that text of her account so buckets two and three perhaps would be in that tax deferred account and maybe you'd keep your liquidity in your taxable portfolio a question we have here is for a younger retiree what's to know how you would change the asset allocation change within each bucket if you say were in your early sixties and we're already retired I think it's really valuable to take a step back and think about your cash flow needs and use that to structure your portfolio so 1 to 2 years worth of living expenses in true cash instruments then again I would say roughly eight years worth of living expenses the next eight years worth of living expenses in largely a high-quality bond portfolio and for that new retiree from a practical standpoint most of their portfolio would go in the equity bucket so I think that it is really valuable to use your cash flow needs as a starting point for how you structure each of these buckets we have a question about inflation and how it could impact the cash part of your your cash bucket if you are worried about inflation is there really anything you can do about that or just cash have to be cash my bias is toward just keeping it in true cash instruments your bucket number one and the fact of life is you know if your bucket one is one to two years worth of living expenses inflation is not going to completely destroy the purchasing power of your whole portfolio for buckets two and three that's where I think you need to think more about inflation protecting those portions of the portfolio so in my model portfolios you saw that tips Treasury inflation-protected securities appeared in bucket two bucket three is very tilted toward equity exposure while equities aren't a direct hedge against inflation they do have overtime have shown the ability to out-earn inflation so I think you want to worry less about inflation protecting bucket one focus more on adding that inflation insulation two buckets two and three how often should you rebalance through buckets is this something that should be happening on a quarterly basis annual basis won't be a good time with quarterly sounds like too much maintenance I mean I think in terms of maintenance the strategy that I really like is setting it up with your financial providers so that your income distributions are funneling right over to that cash account to prove it to provide kind of a baseline of your cash flow needs and then once a year get in there and do that rebalancing and see where you can prune your portfolio and top up your your cash bucket but I think doing it much more than once a year probably is overly complicated the thing about doing the year-end rebalancing too is that you can kind of keep an eye on tax issues as well if you kind of focus that rebalancing process toward the end of a given calendar year well Christine thank you so much for sharing the bucket portfolio Thank You Jeremy it's big huge next we're going to hear from some oyster experts including breast kennel Ben Johnson Sarah Bush they're going to give some ideas of other investments that you can put in your retirement accounts stay tuned that will start in just five minutes

Channel: Morningstar, Inc.

Views: 33,078

Rating: 4.8718534 out of 5

Keywords: morningstar, investing, stocks, funds, etfs, mutual, market, Retirement, Readiness, Bootcamp, Social Security, Pensions, Annuities, Christine, Benz, Maria, Bruno, Vanguard, Jeremy, Glaser, RetireFit

Id: vvgOkbcDxbk

Length: 47min 57sec (2877 seconds)

Published: Tue Mar 21 2017