Investing prior to retirement is a walk in the park compared with investing in the so-called decumulation phase. In the accumulation phase, the tried-and-true mantras of saving early and often and maintaining a diversified portfolio will get you 95% of the way there (and maybe even further).
But managing your portfolio in retirement requires you to sort through many more complex variables, including whether you've saved enough to retire, how much you can safely withdraw without running out of money, and what your in-retirement asset allocation should look like. Add in the current headwinds of low bond yields and worries about future volatility in bonds, and it's no wonder so many retirees are worried about their futures.
The bucket strategy I've been writing about during the past few years creates a simple framework for addressing at least some of these challenges. At its most basic, the bucket approach as envisioned by financial-planning guru Harold Evensky includes two major buckets--one holding liquid assets for living expenses and the other holding longer-term assets such as stocks and bonds. By carving out an adequate pool of liquid reserves for living expenses, the thinking goes, a retired investor can readily ride out the volatility inherent in his or her long-term assets.
In previous columns I've supplied sample "bucket" portfolios (catering to aggressive and moderate investors), but those articles have also sparked questions about the logistics and specifics of bucket portfolios. I'll address some of them here.
Your bucket portfolios include one to two years' worth of living expenses in cash, but cash yields are non-existent. Can I reduce the cash stake and use bonds instead?
While maintaining a dedicated liquidity pool (Bucket 1) is central to the bucket approach, cash has been close to "dead money" during the past few years while bonds have performed much better. Nonetheless, those who leave cash in search of higher yields should do so with extreme care. Yields on cash alternatives like short-term bonds are pretty skimpy, too, yet such vehicles could be somewhat vulnerable to interest-rate and credit-related shocks--in contrast with true cash vehicles.
I'm an income-focused investor and want to avoid invading my principal. How do income-producing securities fit into the bucket framework?
One common source of confusion with total-return-oriented strategies like bucketing is that you're ignoring income producers and instead constantly digging into your principal to meet your living expenses. However, the bucket approach gives you a lot of leeway about how you refill Bucket 1. One of the main ways to do so is to have income from your bonds and dividend-paying stocks flow directly into that bucket. If, after a year of taking in dividend and bond payments, Bucket 1 is full, you're all set. But if that amount isn't sufficient to meet your living expenses for the year ahead, you can sell securities. Such periodic selling might be desirable to restore your portfolio to its asset-allocation targets. The past three years provide a good example of a period when such rebalancing-related selling would be desirable: Bucketers may have found the income from their bond and dividend payers insufficient to meet their income needs, but strong equity performance could mean that it's necessary to trim long-term holdings. My Morningstar article, “Income vs. Total Return: Why Take Sides?”, provides more colour on how income and total-return approaches can peacefully coexist.
I have multiple accounts that I plan to draw from during retirement, including a SIPP, company pension plan and ISA. Do I have to create multiple buckets within each account type?
No. Once you've arrived at your bucket framework--how much and what you'll hold in Bucket 1 as well as your longer-term buckets--you can then think about which account types you'll use to fund each bucket. The overarching idea is that you'd want to liquidate the least tax-efficient accounts first, while saving the most tax-efficient assets for your later retirement years. Assets that will be taxed upon withdrawal could potentially go in the middle of the bucket queue. However, these are just guidelines. The proper sequencing of withdrawals is a highly individualised set of decisions. A financial planning and tax professional can help you make sure you're thinking through all of the proper variables.
