Buckets/ Rebalancing

[WilliamG]

I know there have been several threads on buckets, but Bob has posted a new (to me) article over on his website questioning the efficacy of rebalancing during retirement.

http://bobsfiles.home.att.net/WhatsNew.html

Basically seems to indicate that not rebalancing (or at least infrequent rebalancing) along with taking assets for expenses from the LEAST returning class is the preferrable withdrawal strategy. Goes along real well with buckets approach. Does point out that retirees may get uncomfortable with the high allocation to stocks that will this will result in.

I still would feel more comfortable with buckets approach with some trigger other than say 7 years for moving assets from longer term to nearer term buckets; e.g., an upper limit range on upper buckets?

 

[ChemEng]

How do you determine the least returning class for the next quarter?

 

[hogwild]

I have read both of Ray Lucia's "Buckets of Money" books. The second book presented a method of "refilling" bucket 2 without classic rebalancing. Basically, you set a goal of what percent return you need for your bucket 3. The book's example is 8%. Then, in years where your gain is above 8%, you take the excess and move it to bucket 2. In years where your gain is less than 8%, you would move money from bucket 2 to bucket 3. This is over simplified, but you get the idea.

 

[Rich_by_the_Bay]

I still would feel more comfortable with buckets approach with some trigger other than say 7 years for moving assets from longer term to nearer term buckets; e.g., an upper limit range on upper buckets?

FWIW, Lucia's studies (Buckets of Money) imply that going the full 14-15 years on bonds and cash alone is the best strategy, supported by that recent paper out of Wharton (sorry - reference not handy).

He also advises opportunistic rebalancing here and there - if stocks do great, sweep over to bonds that amount that exceeds your initial expectations for stock performance.

The theory is that time (12-14y for stocks, 7 y for bonds) basically mitigates risk historically (yeah, I know). After 14 years, you replete using stock sales. No problem if they happen to be down a bit at that year -- compared to their gains over the past 14 years, it's nothing more than a blip.

With some modification, that's the general strategy I plan to use.

 

[WilliamG]

How do you determine the least returning class for the next quarter?

The performance is historical. Actually, I think they show bonds before stock as best result as bonds historically have performed behind stocks.

 

[ziggy29]

I have read both of Ray Lucia's "Buckets of Money" books. The second book presented a method of "refilling" bucket 2 without classic rebalancing. Basically, you set a goal of what percent return you need for your bucket 3. The book's example is 8%. Then, in years where your gain is above 8%, you take the excess and move it to bucket 2. In years where your gain is less than 8%, you would move money from bucket 2 to bucket 3. This is over simplified, but you get the idea.

Really? I haven't read these books, but I didn't think Lucia's strategy would work that way (I've listened to his radio show from time to time and I've never heard him say anything about moving from "less risky" buckets to "more risky" buckets, only the reverse).

To me that defeats much of the purpose of the buckets -- a place to stash the "safer" money for a few years' income while you let time smooth out the lumpy returns of the "equities bucket." Removing assets from the safer buckets -- giving you fewer years of "safe" income -- seems to be contrary to the idea that you should have at least X years of safer stuff in the buckets because historically stocks have never lost out to inflation in an X-year period. Leaving yourself with fewer years of income in the safer buckets would seem to make you more vulnerable to a prolonged lousy market like 1966-82.

What's being described sounds more like traditional asset allocation between buckets. I thought the idea behind "bucketizing" (as Lucia calls it) is to live off the "safer buckets" (for up to a decade or more) until excess market returns allow you to refill them.

 

[tomz]

I scanned the paper. I have a question. If you start with a 50/50 portfolio and use the bonds first approach (no rebalancing), eventually the bond portion of your portfolio will be depleted and your portfolio will be 100% stocks. Is this how you interpret the withdrawal methods?

 

[Rich_by_the_Bay]

Really? I haven't read these books, but I didn't think Lucia's strategy would work that way (I've listened to his radio show from time to time and I've never heard him say anything about moving from "less risky" buckets to "more risky" buckets, only the reverse).

To me that defeats much of the purpose of the buckets.

Hog is right. Lucia waffles a bit on the air, but he does advise the occasional rebalancing from B3 to B2 after very good years. Not all the gains, just those that exceed the presumptions in your model. Doing so buys you more time for B3 to sit, more in B2 to wait out the low periods, etc. If you're brave and flush, he even allows for the occasional shopping spree during the early recovering of a down cycle, using B2 funds to buy B3 stocks. True, it begins to sound like a more traditional plan the more you futz around with it.

The main advantage of Buckets for me is that it makes it very easy psychologically and mechanically to live off safe money for a long, long time. It avoids pro rata withdrawals as would occur with target or balanced fund allocations, and the time intervals between major shifts in funds among the buckets is probably twice in your lifetime (14 years twice).

I don't think there is any magic in this, and your risk tolerance can be whatever you want it to be. You start conservative, and your AA gets more aggressive over time (seemingly counterintuitive), but the interval is so long that your risk is not high statistically (and by then your spending is down, social security ongoing, throw in a SPIA if you're nervous).

 

[ziggy29]

Hog is right. Lucia waffles a bit on the air, but he does advise the occasional rebalancing from B3 to B2 after very good years. Not all the gains, just those that exceed the presumptions in your model. Doing so buys you more time for B3 to sit, more in B2 to wait out the low periods, etc. If you're brave and flush, he even allows for the occasional shopping spree during the early recovering of a down cycle, using B2 funds to buy B3 stocks. True, it begins to sound like a more traditional plan the more you futz around with it.

I totally understand the moving from B3 to B2 after good years; that's what continues funding B1 and B2 for many years. What I don't get is moving from B2 to B3 to go "bottom fishing." That starts to sound more like market timing to me.

And how do we know if the "early recovering of a down cycle" is the start of a prolonged higher market (1980, late 2002 and 2003) or a dead cat bounce (1967)? If the former, congratulations; if the latter, you're only deeper in it.

Seems to me that trying to "time the bottom" is more of a wealth maximization strategy rather than a "don't outlive your portfolio" strategy which I thought the "buckets" was supposed to be.

 

[tuffy88]

Buckets

I don't use the buckets strategy, instead going 50-50 stock-bond index funds and rebalancing annually in my primary retirement portfolio. Trade with the IBD Big Picture strategy with a trading portfolio which is an additional 10% of my main portfolio. But in a major downdraft in the market lasting years I would be very uncomfortable watching the % in stocks rise year after year. One way to correct this is to rebalance back to 7 yo 10 years in bonds every time the S&P500 rose 10% from the last setting up of the portfolio. That way in your retirement you would be going back to 7 to 10 years in bonds often during retirement. At least that seems to make sense to me.

Charles

 

[Rich_by_the_Bay]

But in a major downdraft in the market lasting years I would be very uncomfortable watching the % in stocks rise year after year. One way to correct this is to rebalance back to 7 yo 10 years in bonds every time the S&P500 rose 10% from the last setting up of the portfolio. That way in your retirement you would be going back to 7 to 10 years in bonds often during retirement. At least that seems to make sense to me.

But in a "major downdraft" your stocks would probably be a lower or stagnant percent of your holdings, not the other way around, right (they'd lose value faster than your modest SWR).

Still, over the years as you withdraw, their percentage in stocks would rise steadily. I'm a little uneasy with that, too, although less uneasy the more I read (withdrawing bonds before stocks has it supporters). I figure I'll do more B3-to-B2 rebalancing than called for during up years, but it is very comforting for me to know that I had the luxury of sitting on the sidelines for 7 to 14 years without blinking an eye, especially early in FIRE.

In some ways, this is more about how much to hold in cash and bonds versus stocks than it is about buckets.

Don't see doing much B2-to-B3 buying since I agree it's too close to market timing. But the possibility is allowed for within the strategy for those who want it.

 

[hogwild]

Really? I haven't read these books, but I didn't think Lucia's strategy would work that way (I've listened to his radio show from time to time and I've never heard him say anything about moving from "less risky" buckets to "more risky" buckets, only the reverse).

You can hear an example at:Business TalkRadio.net - The Ray Lucia Show
Listen to the 9/25/07 archive, 1st hour at approximately the 48 min mark.

 

[youbet]

In some ways, this is more about how much to hold in cash and bonds versus stocks than it is about buckets.

So.......it's about Asset Allocation?

 

[audreyh1]

The only thing I take from the "buckets" strategy is to keep 2 to 3 years of living expenses cash in a separate account from my retirement portfolio. I sort of "stumbled" onto this method accidentally but quickly learned that it worked very well for us. It is purely a way of managing any personal anxiety that results from market fluctuations. It means you don't sweat the short term (< 2 years) stuff.

Otherwise, the retirement portfolio itself is classic AA with occasional (at least 1 year but no more than 2 years) rebalancing. This is an attempt to maintain a fairly constant risk profile. Simple and straightforward. No weird rules about when to take from what.

I value lowering volatility/preserving capital (while still protecting from inflation) over maximizing long term returns.

Audrey

 

[ziggy29]

I value lowering volatility/preserving capital (while still protecting from inflation) over maximizing long term returns.

Yep. Investing to maximize the expected value of one's portfolio and minimizing the chances of falling short of your goals are two different things.

With the former, find the highest risk/reward asset classes and let them fly forever. With the latter, find the "efficient frontier" -- given a certain amount of risk I'm willing to take, how can I build a portfolio to maximized expected return consistent with that reduced risk profile?

I'm there with you. I'm already more conservatively invested than I probably should be at my age (42 next week), but I did well enough for the last 18 years of investing that I can probably reach my goals (and minimize my chances of falling short) by playing it a little more conservatively. Hence only about 60% of my allocation is in traditional equities.

 

[teejayevans]

To me that defeats much of the purpose of the buckets -- a place to stash the "safer" money for a few years' income while you let time smooth out the lumpy returns of the "equities bucket." Removing assets from the safer buckets -- giving you fewer years of "safe" income -- seems to be contrary to the idea that you should have at least X years of safer stuff in the buckets because historically stocks have never lost out to inflation in an X-year period. Leaving yourself with fewer years of income in the safer buckets would seem to make you more vulnerable to a prolonged lousy market like 1966-82.

Try to think of it this way: if in year 0 you bucketize, and the market goes up,
then in year 2, you can start the process again, and your good for another
15 years. But if you ever start during a downturn, then yes, you have 15
years to recover. Thats the point of bucketizing.
TJ

 

[ziggy29]

Try to think of it this way: if in year 0 you bucketize, and the market goes up,
then in year 2, you can start the process again, and your good for another
15 years. But if you ever start during a downturn, then yes, you have 15
years to recover. Thats the point of bucketizing.TJ

I repeat -- I understand the moving from the "risky" bucket to the "safe" buckets when the market is booming. What I don't get -- and seems contrary to the safety built into bucketizing -- is transferring from the safer buckets to the riskier buckets. I've seen it explained here that the Lucia strategy allows for that option, but to me, transferring in *that* direction (from bucket 2 to bucket 3, for example) runs contrary to what bucketizing is supposed to accomplish. I fully understand the concept of moving from B3 to B2 when stocks are soaring.

 

[Rich_by_the_Bay]

I repeat -- I understand the moving from the "risky" bucket to the "safe" buckets when the market is booming. What I don't get -- and seems contrary to the safety built into bucketizing -- is transferring from the safer buckets to the riskier buckets.

In a way, you're right. Once taken off the table by being put in b2 or b1, that money should be considered unavailable for more aggressive investing. That's the way I plan to do it.

The backfilling from b2 to b3 opportunistically goes against the grain for the buckets philosophy. I think it's anomaly that few would be well advised to do. Consider it to be like "cheating" by putting some play money into your individual fund or stock of choice.

That aside, the plan generally nudges you in the right direction for most planning decisions in the drawdown phase, at least for me.

 

[tuffy88]

+8% return for bucket 2.

I don't think one is going to get more than +8% in bucket 2 very often. I have not read Lucio's books, so for you who have read them what assets does he invest in that gets more than +8% in a bucket that is lower risk than equities? Convertable & high yield bonds, closed end bond funds. Neither is low risk. Something like Vanguard Wellesley or Wellington, Dodge & Cox Balanced Fund, or the like might do it, but they have quite a few stocks in them. Would they be considered low risk enough for bucket 2? They seem to me about the best for Bucket 2 if you are gunning for an +8% return for bucket 2.

Charles

 

[Rich_by_the_Bay]

I don't think one is going to get more than +8% in bucket 2 very often. I have not read Lucio's books, so for you who have read them what assets does he invest in that gets more than +8% in a bucket that is lower risk than equities?

Don't know of anyone who would count on 8% from B2 (though you might get lucky with a balanced fund); 6% is more like it, with 8% being a conservative assumption for B3.

Do yourself a favor and get the buckets book from your library (Lucia). Even if it doesn't work for you at least you'll understand it better. It's a reasonably entertaining read.

 

[mathjak107]

you rebalance between buckets based not on gains but on years worth of money. thats the big difference. you can balance between what you have in the buckets if you so choose but not necessary unless you have sector funds or areas that really sored ala tech heavy funds in the 90's.


the whole idea is that rays plan revolves around getting a certain average return from each bucket with a risk level to match that income you desire.

if you have 7 years money in bucket 1 and bucket 2 you may choose to leave bucket 3 alone even though it may have had a large run up...

or you may choose to just balance out bucket3 moving to different style funds. its a lot more interesting than just when you rebalance by percentages in stocks bonds or cash

 

[mathjak107]

Don't know of anyone who would count on 8% from B2 (though you might get lucky with a balanced fund); 6% is more like it, with 8% being a conservative assumption for B3.

Do yourself a favor and get the buckets book from your library (Lucia). Even if it doesn't work for you at least you'll understand it better. It's a reasonably entertaining read.

i agree, rays working numbers are 4% in bucket 1 and 5% in bucket 2. with an overall % for all buckets of around 7% in my case

 

[teejayevans]

i agree, rays working numbers are 4% in bucket 1 and 5% in bucket 2. with an overall % for all buckets of around 7% in my case

I like the first book, he kept it pretty simple and it includes the tables
to make calculating how much in each bucket.

Lately he has been modifying it with more buckets and more complex
strategy, including moving $ between buckets going in both directions.
Moving $ from B2 to B3 only makes sense if B2 is overfunded, which it
will be if you have moved $ from B3 to B2. Personally I think he is making
too complicated (but you got sell more books I guess).

Lately he has been pushing life annuities because some study said you
have a better chance of not outliving your investments if you have up
to 50% of your income from annuities. To me, if you use buckets, you
don't need annuities because you have a safe investment to withdrawal
while the rest of your investments recover.

The radio show is pretty good, but sometimes the size of his ego annoys
me. The whole "brain trust unmatched anywhere on this planet" <we need
a smiley face throwing up>
TJ

 

[CuppaJoe]

Lately he has been modifying it with more buckets and more complex
strategy, including moving $ between buckets going in both directions.
Moving $ from B2 to B3 only makes sense if B2 is overfunded, which it
will be if you have moved $ from B3 to B2. Personally I think he is making
too complicated (but you got sell more books I guess).

Lately he has been pushing life annuities because some study said you
have a better chance of not outliving your investments if you have up
to 50% of your income from annuities. To me, if you use buckets, you
don't need annuities because you have a safe investment to withdrawal
while the rest of your investments recover.

The radio show is pretty good, but sometimes the size of his ego annoys
me. The whole "brain trust unmatched anywhere on this planet" <we need
a smiley face throwing up>
TJ

Yes, where is that throw-up smilie. Imagine, a self help book that tells me the premise is too complicated for a DIYer and I must go out a look for an adviser. Poorly written books, (although most basic financial advice books are skim and toss back in the library), his are particularly annoying. Not to worry, his resale value is good at Amazon.

Curious aside: Both my local independent bookstore and membership library do not stock his books; perhaps a "West Coast bias" but I wonder. If any library patron had requested purchase of his books, they would be on the shelf. This particular library, costing $100/yr membership, has many wealthy patrons many many of whom are retired and the finance section is generally very good, including newletters.