The simplicity of a bucket system for retirement asset allocation and withdrawals may be just what clients need, according to Christine Benz – but the system does come with a few drawbacks that could be exacerbated by depressed market returns over the next decade.
The three-bucket system for retirement asset allocation championed by Benz, who is Morningstar’s director of personal finance, has come to be embraced by do-it-yourself investors who value simplicity over efficiency, but had its origins among professional financial advisors.
Benz noted in “With the Bucket Approach, the Devil is in the Details,” a Wednesday morning presentation to advisors at NAPFA’s fall 2019 conference in Chicago, that one of the earliest retirement bucket systems was proposed by financial advisor Harold Evensky as an easy way to organize a retiree’s portfolio by spending horizon.
“He said that having a cash bucket bolted onto a long-term portfolio was amazingly useful in terms of keeping his clients in their seats through periods when the market was rocky and stocks were tumbling,” said Benz. Evensky was pioneering a two-bucket system in which retiree’s short-term spending needs, enough to cover approximately two years worth of expenses, was kept in a bucket of cash and cash equivalent investments like CDs and money market mutual funds. The rest of a client’s portfolio was allocated conventionally.
Benz is a stronger proponent of a three-bucket system, in which one bucket mirrors Evensky’s short-term, cash-focused innovation, a second contains enough assets to cover three to eight years of expenses and contains mostly investment-grade fixed income instruments, and a third portfolio is intended for long-term investments in globally diversified equities and high yield bonds. The third bucket would also hold investments like REITs and multi-sector bond funds whose year-to-year value and returns could be volatile.
In a three-bucket system, retirees would tap their short-term cash bucket for portfolio income first, followed by the mid-term fixed income bucket, and finally the long-term equities bucket.
Benz said that a similar system has been proposed by retirement researchers Michael Kitces and Wade Pfau, who additionally argued for a “reverse glide path” for retirement portfolio allocations that would gradually add more risk into a retiree’s investments after they leave the workforce and as they aged.
Benz believes that a portfolio’s ideal glide path after retirement depends on the end investor’s goal. If they want growth in the portfolio, perhaps to increase the value of their estate or to boost their charitable giving, then the reverse glide path that adds risk throughout retirement may be appropriate. On the other hand, if the investor wants to spend down their portfolio and deplete their wealth through retirement, a more conservative glidepath is appropriate.
In Benz’s system, the short-term bucket of cash equivalents would be continuously replenished by selling investments from the mid-term and long-term buckets – giving advisors an opportunity to be opportunistic about how a client’s cash assets are replenished.
“One of the advantages of the bucket approach is that retirees know that their near-term income needs are set aside in cash investments,” said Benz. “The bucket approach can be a really great illustration tool – I hear from individual investors that they really get what we’re talking about, they understand the why behind asset allocation because they’re thinking ahead about the withdrawals that they may take from the portfolio.”