Investing Specialists

What Do the Bucket Portfolios Yield?

Christine Benz

"What kind of income do your Bucket portfolios generate? I'm retired, and yield is the name of the game for me."

I've gotten that question off and on over the past several years, and I received it again recently. Even though the Bucket portfolios focus on total return rather than generating current income, retirees often prioritize yield, for many reasons.

There's a psychological benefit to income-generating securities, of course: Current income is like the paycheck retirees received while they're still working. And there are solid financial reasons to like yield, too. After all, income is the lion's share of your return as a bond investor, and dividends have composed a big share of the equity market's long-term return.

A security's ability to produce yield is arguably a particularly big attraction right now. While the economy is still strong, it's been a long expansion. Paying a dividend is an important show of financial wherewithal, so it stands to reason that dividend-paying firms will hold up better than the broad market in a weakening economic environment. (That wasn't the case during the financial crisis, though, as financials were at the epicenter of the mortgage meltdown and banks were forced to slash their dividends.) Moreover, if the market's return over the next decade is muted--and many market experts expect that will be the case--it's not unreasonable to be in "show me the money" mode.

Finally, while I've often argued that retirees shouldn't prioritize income production because it can lead them into risky territory, I do think yielders can work well as part of the Bucket approach. As a retiree spends from Bucket 1 (cash for ongoing living expenses), he or she can refill it, at least partially, with current income distributions. If those distributions are insufficient to refill Bucket 1 entirely, rebalancing proceeds can make up the difference.

The good news for yield-seekers is that my baseline Bucket portfolios--both those composed of mutual funds and ETFs--have seen their yields tick up since I last shone the spotlight on their income production in September 2017. That means that bucketers can refill Bucket 1 with more income than was the case in the past; they'll need to rely less on market appreciation and rebalancing proceeds to do the heavy lifting. While five of the six portfolios were yielding less than 2% 18 months ago, now all of the portfolios feature yields that are north of 2.5%. That's the result of two forces. First, Fed tightening over the past three years has put upward pressure on bond yields. In addition, yields on lower-quality, credit-sensitive bonds jumped in the fourth quarter of 2018, plumping the payouts on portfolio holdings like  Loomis Sayles Bond (LSBDX),  Vanguard High-Yield Corporate (VWEAX), and  Fidelity Floating Rate High Income (FFRHX).

Bucket Basics
The Bucket strategy is an intuitive way to organize a retirement portfolio, in that a retiree only takes as much risk as he/she can afford to take given the anticipated spending horizon. In my three-bucket system, assets for the next year or two go in cash (Bucket 1), enough assets for the next eight or so years are earmarked for high-quality bonds (Bucket 2), and the remainder of the portfolio can go into higher-returning, higher-risk assets, primarily stocks but also small positions in lower-quality bonds. Buckets 1 and 2 provide a bulwark against having to sell equities in a trough, and they also provide a valuable intangible once the spend-down phase begins: peace of mind.

Retiree spending drives the size of each bucket. As a result, retirees who are relying on nonportfolio resources (such as a pension) to fund a large share of their living expenses will maintain light positions in Buckets 1 and 2, whereas those who are relying mainly on their portfolios would have larger stakes in cash and bonds. My model portfolios are in place to depict sensible proportions of various asset classes, but investors should customize their own portfolios with their withdrawal amounts as the starting point, as discussed here.  

To date, I've created core model portfolios for mutual fund and ETF investors; each series has an aggressive, conservative, and moderate version. These core portfolios are designed for investors in tax-sheltered accounts (e.g., IRAs), but I've also created tax-efficient bucket portfolios (for investors' taxable holdings). And for investors who prefer to have their assets with a single firm, I've created fund-family-specific portfolios for Vanguard, Fidelity, T. Rowe Price, and Schwab supermarket investors. (We've aggregated all of the portfolios--along with related articles about bucket portfolio performance and maintenance--on this model portfolios page.)

A Yield Checkup
To calculate yields for each of the portfolios, I retrieved SEC yield figures for each holding and weighted them by each holding's value in the portfolio. The bond holdings generally have higher yields than the stock holdings. Thus, it's not surprising that the bond-heavy conservative portfolios feature the highest yields, whereas the aggressive versions, which are dominated by equity holdings, have the smallest. The portfolios get a yield pop from their modest stakes in lower-quality bonds via holdings like Loomis Sayles Bond, Fidelity Floating Rate High Income,  SPDR Blackstone Senior Loan ETF (SRLN), Vanguard High-Yield Corporate, and  iShares JP Morgan USD Emerging Markets Bond (EMB).

Mutual Fund Bucket Portfolio Yields: February 2019
Aggressive: 2.57%
Moderate: 2.67%
Conservative: 2.74%

Fidelity Floating Rate High Income, a small position in the moderate and conservative portfolios, has by far the highest yield in the portfolios, followed by Loomis Sayles Bond, which appears in all three. Both funds saw their yields shoot up, and their portfolios log losses, in the fourth quarter of 2018. Equities were down during November and December, and lower-quality securities often move in sympathy with the equity market.  Vanguard Wellesley Income (VWIAX) and  Harbor Bond (HABDX) both have yields well north of 3% currently, too. Perhaps the biggest yield pickup since my last review, however, comes from the lowly old cash holdings. Whereas cash yields were below 1% 18 months ago, today it's not hard to pick up a yield in the 2.5% range on a high-quality money market fund. (I use Vanguard Prime Money Market as a cash proxy for these portfolios; its SEC yield was recently 2.46%.)

ETF Bucket Portfolio Yields
Aggressive: 2.56%
Moderate: 2.77%
Conservative: 2.82%

Note that the moderate and conservative ETF Bucket portfolios have higher yields than their mutual fund counterparts. While the yields on their equity and high-quality bond positions have yields that are roughly equivalent to the holdings in the mutual fund portfolios, the aggressive fixed income holdings have notably higher yields than Loomis Sayles Bond. iShares JP Morgan USD Emerging Markets Bond and Vanguard High-Yield Corporate, while consuming just 3% of the portfolio apiece, each yield nearly 6% today.

Takeaways
On the plus side, increases in prevailing yields make it easier for retirees to derive a healthy portion of their cash-flow needs from income-producing securities than was the case in the past. While the equity holdings in the portfolios have yields in line with the broad market's, income-minded retirees could reasonably bump up their portfolios' payouts by embracing a stake in a higher-yielding equity fund for a portion of their equity holdings.  Vanguard High Dividend Yield Index (VHYAX)/(VYM) is a favorite for Morningstar's analyst team. Rather than go all-in on such a fund for market exposure, my preference would be to pair it with a broad market index fund for better diversification.

Yet the fourth quarter of 2018 also provides a cautionary notice about the perils of stretching for yield, especially on the fixed-income side. While yields on credit-sensitive bonds spiked during the quarter, the bond prices slumped. If investors are concerned about equity valuations these days, it's important to remember that such bonds often move in sympathy with stocks. 

Christine Benz does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.