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Investing Specialists

A Year-End Bucket To-Do List

These seven steps tackle a lot of jobs: refilling cash, rebalancing, tax planning, and charitable giving.

A version of this article previously appeared in December 2020.

One of the best parts of employing a Bucket approach to retirement portfolio management is that you don't have to be terribly hands-on. A thorough, once-a-year checkup is all you really need to keep your buckets up and running.

Year-end is an ideal time for that type of maintenance, in that you can tackle a lot of smaller portfolio-management jobs all in one go: rebalancing, filling up your cash bucket, charitable giving, and tax-loss (or tax-gain) harvesting, for example.

If you're employing a Bucket strategy, here are the key items to have on your docket as 2021 winds down.

Step 1: Check This Year's Spending Rate

When you're accumulating assets for retirement, your savings rate is one of the best measures of whether your plan is on track. But when you transition into drawdown mode, your spending rate--how much of your portfolio you're spending annually--is the make-or-break number.

Thus, the first step in any retiree's annual checkup--whether you're using a Bucket strategy or some other approach--is to assess how much of your portfolio you've spent this year. To help gauge your spending rate, total up all of your portfolio withdrawals for 2021, then divide that number by your portfolio balance, ideally from the beginning of this year. Does it pass the sniff test of sustainability

Remember--not everyone needs to spend 4% year in and year out. People who are well into retirement can reasonably spend more--using required minimum distributions as a starting point, for example. Meanwhile, new retirees may want to spend less than 4% if they can swing it. That's largely because bond yields are so very low, and therefore portfolios that rely upon them are similarly constrained. In addition, equity valuations in the United States aren't cheap. Both of those issues raise the possibility that the next decade could be challenging for new retirees. Being able to get by on less if the early retirement years happen to coincide with a bear market can help ensure that enough of your portfolio is in place to recover when the market eventually does.

Step 2: Assess Cash Needs for the Year(s) Ahead

The next step as you refresh your buckets for 2022 is to forecast your cash flow needs. In addition to the funds you need for your routine living expenses, are you expecting to make any out-of-the-ordinary outlays next year, such as a new car, major trip, or home repair/upgrade? How do you expect inflation to affect your expenses?

Armed with an all-in budget for the year ahead, you can then look at how much of your total outlays will be met through non-portfolio-income sources--Social Security, a pension, a fixed annuity, and so forth. Subtract those income sources from your total planned spending to arrive at your planned portfolio withdrawal, and check its sustainability.

Document your portfolio spending need; we'll come back to that number in a moment. If your Bucket strategy entails holding two years' worth of portfolio withdrawals in cash--and I think that's advisable because it can provide a bit of a buffer in weak markets--forecast your cash flow needs for both 2022 and 2023.

Step 3: Size Up Bucket 1

Once you've arrived at your cash needs for the year(s) ahead, compare that with your current liquid reserves on hand. If you've been steering dividends and bond income back into your cash bucket over the past year (part of a "hybrid" strategy for bucket maintenance, or you have cash left over for any other reason), you've probably filled up your cash bucket (at least by a bit) and will need to lean less on rebalancing for the job. Subtract current cash reserves from the cash needs you arrived at in Step 2; the amount left over is the additional amount you'll need to extract from your portfolio from rebalancing.

Step 4: Assess Long-Term Asset Allocation

Next, take a look at your long-term portfolio using Morningstar's X-Ray functionality, which depicts your actual asset-class exposures based on the composition of your holdings. Take note of your portfolio's current allocation relative to your asset-allocation target as laid out in your investment policy statement. If you have a healthy complement of stocks in your portfolio, it's likely that portion has appreciated nicely over the past few years and is taking up a larger share of your total portfolio than you intended it to.

Step 5: Source Cash for Bucket 1

Identifying overweight positions in your portfolio will point you toward those areas that you can trim if you need to top up your Bucket 1/cash holdings, as discussed above. For most investors, as 2021 winds down, selling appreciated equity holdings is a logical place to start if they need to raise cash.

Specifically which equity holdings you sell to raise cash will depend on what sequence of portfolio withdrawals you're using for your accounts. This is a good spot to get help from a tax professional.

Step 6: Identify Additional Rebalancing Needs

Pulling your cash needs from appreciated holdings may be sufficient to restore your baseline asset-class exposures back to your targets. However, it's a good bet that additional rebalancing may be in order, especially because 2021 has been such a good year for U.S. equity investors, following on strong performance in 2019 and 2020. Foreign stocks, have done OK, too, but not as well. As a result, you may want to pull additional amounts from your appreciated U.S. equity holdings--above and beyond the amount needed to refill Bucket 1--to restore your bond and foreign-stock allocations to your targets. Also pay attention to your equity style-box positioning. 

The market rally has been broad-based, but you may be able to identify candidates for tax-loss selling, especially among your bond holdings, individual stocks, or region- or sector-specific funds.

Step 7: Tie in Charitable Giving

Last but not least, if you're charitably inclined, it may make sense to tie in charitable gifts with the steps outlined above. For example, you might want to direct a portion of your rebalancing proceeds to charity via a qualified charitable distribution, assuming you're at least age 70 1/2. The amount of the QCD reduces taxable income and also reduces the amount of your IRA that will be subject to RMDs in the years ahead.

Alternatively, if your rebalancing plan involves taxable accounts, you might consider taking advantage of 2021's outsize gains to make a larger-than-usual contribution to charity. With higher standard deductions in force today, the strategy of "bunching" charitable contributions in order to exceed the standard deduction threshold makes more sense than ever.