More Buckets, Portfolio Allocations, and Rebalancing

[tomz]

With all the discussion here regarding Buckets, I decided to attempt some real-world modeling using Firecalc to provide historical returns. After plugging into Firecalc my projected expenses and income, I have consistently hit 100% success. I wanted to see how the portfolio would do during some nasty bear markets.

• I entered 0 expenses and a starting portfolio of $100 with no additional income for a 10-yr period. This made it easy to see upward or downward trends.
• Then, I changed the asset allocations to look at 50/50, 20/80, 10/90, 100/0 and 0/100 stock vs bond portfolios.
• I put the results into a spreadsheet and calculated annual gain or loss for every year for each portfolio in Firecalc.
• Next I setup my buckets based on what I plan to have in retirement. I put about 6 yrs of living expenses into bucket 1. I subtracted my projected annual expenses from bucket 1 and calculated the gain or loss for the other 2 buckets over the 10-year period using the Firecalc numbers.

I have a different spreadsheet for each 10-year scenario that is particularly nasty (like 1969-1979) and played around with rebalancing and different portfolio allocations. 1969 - 1979 provided some interesting scenarios. In a bear market, your savings can get clobbered real fast. One or 2 bad years within a few years of each other can deplete all your buckets. I'm not sure I'm brave enough to take funds from bucket 2 and put them into bucket 3 after taking a -3% return on bucket 2 and a -26% return on bucket 3 and then 3 yrs later see another -12% return in bucket 3.

Sorry for the length of this, but I wanted to see how the bucket theory worked using actual returns. In my case, after 4 hrs in front of the computer, my head was spinning and I wasn't sure I would ever be able to RE. Plugging numbers into a retirement calculator may give you a false sense of security. In retirement, you still have to make the decisions about rebalancing and allocations when the market is down. If you guess wrong, your 100% success rate can drop very fast.

 

[JohnEyles]

Plugging numbers into a retirement calculator may give you a false sense of security. In retirement, you still have to make the decisions about rebalancing and allocations when the market is down. If you guess wrong, your 100% success rate can drop very fast.

I think the point is not to "guess about the decisions about rebalancing and allocations"
(that is market timing !) but rather to have hard and fast rules and stick to them.
The most basic rule is to maintain allocations with periodic rebalancing. The buckets
idea requires more guessing, unless rules are given and shown to back-test better;
but so far that hasn't happened, and I'm starting to lean away from buckets.

But you make a great point, which is that massive amounts of research is done (and
calculator tools written) to determine a good SWR, but not that much is said about
how to insure that you manage the draw-down so that this WR really IS safe.

One thing that I rarely see addressed is the issue of growth vs value investments
in a retiree's portfolio. Total return is total return. But people seem to imply it's
a good thing if the yield part of total return covers your WR and the growth part
covers inflation. But, at least recently, value funds seem to dramatically out-perform
growth funds, so, since total return is all that matters, why have growth funds ?
Is this outperforming of value over grwoth just a recent phenomenon, or what ?

 

[ats5g]

Since we've been on the topic of how to withdraw money from a retirement portfolio, you guys should check out Retire at the Pie Shop. The author is a poster over at M* Investing During Retirement Forum. Anyway, start at Chapter 7: Sample Year 1. Bob gives good concrete examples of how to prune various investments in retirement to avoid reverse DCA. He uses the Coffeehouse portfolio in his examples and the years 2000-2005.

His strategy is basically sell whatever is doing the best, as outlined in Frank Armstrong's Investing During Retirement [see page 9]:

Withdrawal Strategy – Preserve Volatile Assets in Down Markets

A rational withdrawal strategy will recognize that equities are volatile and short-term bonds are not. So, we employ a specific strategy designed to protect volatile assets during down market conditions. Otherwise, excessive equity capital will be consumed during market downturns.

Most advisors have been content to treat retirement assets as a single portfolio. For instance, many would advocate a “life style” portfolio comprised of 60% stocks and 40% bonds. However this leads to withdrawals on a pro rata basis from both equity and fixed assets regardless of market experience. It does nothing to protect volatile assets during down markets.

A far superior alternative strategy would treat the equity and bond portfolios separately, then impose a rule for withdrawals that protects equity capital during down markets by liquidating only bonds during “bad” years. During “good” years withdrawals are funded by sales of equity shares and any excess accumulation is used to re-balance the portfolio back to the desired asset allocation. Again, using spreadsheet models with Monte Carlo simulation we find substantial incremental improvement by imposing this simple rule.

His site also has links to every withdrawal article I can think of.

- Alec

 

[tomz]

Thanks - I read the Pie Shop stuff a few months ago and actually had it in my Favorites. I've gotten so caught up in all this bucket stuff, that I forgotten I already had a good strategy for withdrawal.