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Investing Specialists

Takeaways from the Bucket Portfolio Stress Tests

Any sane in-retirement strategy would've done OK from 2000-17. But will history repeat?


I periodically revisit the performance of my bucket portfolio--and various variations on it--with a few goals in mind.

A key objective--and one of the underpinnings of the bucket portfolios in the first place--is to demonstrate the logistics of extracting cash flow from a portfolio in today's low-yield world. How can retirees maintain a total return portfolio and live on rebalancing proceeds rather than gunning for income? My backward-looking performance reviews, complete with spreadsheets, aim to demonstrate the nitty gritty of portfolio maintenance and cash-flow production.

Additionally, by reviewing how model portfolios with varying allocations and maintenance regimens would have behaved in the past, my aim is to arrive at some "best practices" for retiree portfolio allocation and management.

Here are some of the key conclusions from the recently completed review of bucket portfolio performance. (For your reference, here's my recent discussion of how the Aggressive Mutual Fund Bucket Portfolio would have performed from 2000-17, and here's an article exploring some variations of that bucket portfolio.)

A Rising Tide Lifts All Portfolios and Strategies…For Now
The 2000-17 time frame covered by my recent bucket stress test featured its share of potholes--and even a couple of craters. The period started off on an ominous note, with a major sell-off in technology stocks rocking growth stocks and the S&P 500. Seven scant years later, the financial crisis arrived and persisted through early 2009; the S&P 500 lost more than half of its value during that period. But the market has been quite robust over the past 18 years overall, culminating in a nearly unbroken string of strong returns for the past nine years. Bonds have been no slouch, either, thanks to an accommodative Fed policy during most of that period. The yield on the 10-year Treasury stood at nearly 7% as 2000 dawned; today it's less than half that.

The fact that the most recently examined time period ends on such an up note means that nearly any sane in-retirement portfolio strategy involving stocks and bonds would have fared at least reasonably well. In all three of my portfolio simulations (baseline aggressive bucket portfolio, single balanced-fund portfolio, and fully invested portfolio), all three portfolios met the target cash-flow needs and grew principal comfortably above the level where they started out. The portfolios' 4% starting withdrawal rate--with an annual inflation adjustment when the portfolio gains in value--was also too miserly over this particular time frame.

That sort of performance trend can breed complacency; you might feel comfy running with a higher equity weighting than you started out with, take a larger withdrawal amount, or assume that your portfolio will always return X% because it just did for nearly 20 years. If any old dart could hit its target over the past 18 years, do you really have to be so vigilant? The short answer is yes. Because the market is so cyclical, very strong performance often portends weak environments, during which you'll be glad you maintained a reasonable withdrawal rate as well as an allocation to conservative investments that you can pull from when your stock holdings are in the dumps. 

Cash Has Been a Drag Since 2000, But May Not Always Be 
In a related vein, the cash "bucket" that I included alongside my baseline portfolio simulation was dead money during the 18 years examined. (Thankfully, inflation was pretty low during this period, too.) Indeed, the fully invested portfolio without any cash holdings outperformed the portfolio with a cash bucket. That makes sense when you think about it: Bond-fund holders benefited from declining interest rates for much of those 18 years, whereas cash holders had to settle for ever-lower yields and don't receive a principal adjustment when interest rates drop.

Is that an indictment of holding cash? Not necessarily, as the cash component no doubt provided some peace of mind in times of turbulence for stocks and bonds. And in a period of sustained rising interest rates, all of the same things that worked against cash holders when rates were falling should be a help: Cash investors receive the benefit of higher yields without principal-related volatility. However, the fact that over long periods of time cash has returned less than bonds and stocks is an indication that investors should use cash judiciously. I'd recommend anywhere from six months' to two years' worth of portfolio withdrawals in cash--no more.

Discrete Holdings Are a Total Return Retiree's Friend
My portfolio maintenance regimen for the baseline bucket portfolio called for pruning holdings when they exceeded 110% of their starting values. The big benefit to that approach (or some type of surgical, security-specific rebalancing method) was that there was almost always something hitting its rebalancing threshold, which in turn could be harvested for living expenses. At the beginning of the simulation in 2000, for example, value stocks performed tremendously well even as growth stocks slumped. By contrast, traditional rebalancing calls for scaling back positions only when the portfolio's total exposure to a given asset class (stocks or bonds) exceeds its threshold. That yields fewer rebalancing opportunities.

However, the 110% strategy that I employed introduced idiosyncracies of its own; in an upward-trending market, the net effect of having to prune holdings all the time was that the short-term bond bucket (the holding pen for assets not needed after harvesting that year's living expenses and topping up appreciated positions) grew incredibly large. One workaround (albeit not necessarily simpler) would be to set the portfolio's target intra-asset-class exposures--for example, 23% in large value stocks--and trim when positions exceeded that level.

Simplicity Is A Virtue--To A Point
As I updated the spreadsheets, I'll confess that I thought, "For goodness' sake, couldn't this process be simplified?" With streamlining in mind, I stress-tested a radically simpler portfolio— Vanguard Balanced Index (VBINX) as well as a cash "bucket." The results were disappointing, in large part because the all-in-one fund didn't allow for pruning/rebalancing in the same way that the multifund portfolio did. In the end, that portfolio returned $400,000 less than the multi-fund portfolio.

But while taking the long-term portfolio to a single fund may not be the way to go, a retiree could still strip down the portfolio to its essence by holding a total U.S. stock market index fund (or ETF), a total international index tracker, and a bond index fund. I'd also argue that inflation-protected bonds deserve a slot in such a portfolio, in that they help insulate a portfolio's bond position from the ravages of inflation. While such a portfolio wouldn't afford as many opportunities for rebalancing as would, say, one that held discrete growth and value holdings and separated developed markets from emerging-markets equities, it would certainly be simpler to oversee on an ongoing basis.

Christine Benz does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.