What are buckets and diversification worth?

[obryanjf]

OK, one more before the road tomorrow (I might eventually drive NORDS to the nut house with this one though).  Now there was a question recently as to the best way to take out of equity and into cash reserves and I’ve been wondering which model/s are better and by how much.  I’ve also been wondering if there were a way to quantify what buckets and/or diversifying is worth in dollars and/or SWR terms.  This will not get at how to transfer assets to cash to maximize whatever, but rather using buckets and diversifying and what that might be worth. 
My buckets approach is Guyton’s; 3 buckets, cash gets refilled with excess allocations in fixed and equity, when + return. Then fund withdrawals from excess allocations in bonds and equities, then cash. If more withdrawal is needed then take from highest equity return to smallest, then fund from fixed.
For the record, the simulations were set up as follows;
5% initial withdrawal, Hybrid model (50%/50%), 40 year sim, 1MM portfolio, No extras included, No Ty Bernicke, Fail on < 50% withdrawal.
The Buckets were; Cash = TBills, Bonds = 5 yr Bonds, Equity non diverse = S&P 500, Equity Diverse Basket with average return slightly lower than the S&P 500 includes; Small value, large value, small growth, large growth. Hyper Diverse is a hypothetical basket of diverse assets which I think would include; REITs, US micro, small, large, value, growth, commodities, international, bonds etc.  I have no data for the Hyper Diverse basket, so those results are left to the imagination.





S&P
|Diverse Basket|
Hyper Diverse



Buckets 
Bucket %
NW SD/Ave
|NW SD/Ave|



Equity     
0,0,100
49 % /10.6MM
|40 % / 18.3MM|
imagination
                                                                             

Cash/Equity 
10,0,90
37 % / 8.9MM
|32 % / 16.9MM|
imagination
           

Cash/Bonds/Equity
10/20/70
32 % / 5.3MM
|26 % / 8.8MM|
imagination



To avoid emotional acronyms, I’ll define the BWR (breaking withdrawal rate) as the withdrawal rate below which there are no failures in the model.  So the BWR is the first withdrawal rate as I iterate thru the model which causes a positive number of failures.  The BWR’s are listed below:



S&P
|Diverse Basket|
Hyper Diverse


5.1
|5.4|
imagination


5.1
|5.7|
imagination


5.2
|5.6|
imagination



Conclusions:  (Working top to bottom) Buckets are beneficial in terms of lower net worth volatility, at a price of lower average net worth.  This is likely due to having more $ in less risky/less return assets as a result of splitting the nest egg into multiple buckets.  The movement (increase/decrease) of the BWR is minuscule art best.  The BWR in a diverse model (from top to bottom) increases only slightly even though one would think we are sweeping the excess returns in an orderly way and optimizing the draws.   Working left to right or getting more diverse with non correlated assets, the volatility goes down and the NW goes up, a very interesting feat.  On the BWR table (left to right) the rates are definitely increasing.
Surely this is the conventional wisdom you say, but again my goal was to quantify it a bit.  Now it’s just a wag on my part, but using multiple buckets and a hyper diverse asset allocation will likely have serious reductions in NW volatility, corresponding increases in NW, and ‘could’ support higher levels of withdrawals throughout a retirement.  This is more possible today than previous generations due to more open financial markets, ETF’s, global funds, etc. 
I have never been accused of being academically rigorous and I do not put this forth as an exhaustive study.  Just interesting to do and imagine the hyper diverse case.

job

 

[cute fuzzy bunny]

This is likely due to having more $ in less risky/less return assets as a result of splitting the nest egg into multiple buckets. ...
This is more possible today than previous generations due to more open financial markets, ETF’s, global funds, etc.

Very interesting, although its possible that more access to different asset classes will produce lower returns on those classes, since only select individuals and groups had access to them before.

or maybe the returns will be higher due to more money being put to work.

And I still dont see any predictability to make me want to use the word "likely" in conjunction with predicting market returns!

 

[obryanjf]

While all the above could be true, I do not have my crystal ball to tell me what will happen in the future. All we have to model with, is past returns. At least that is all I have.

So I agree that I do not know the future, that it may be different and that if it is then the models will be wrong one way or the other.

My point was to provide some sense of the value of buckets and diversification. To me if appears buckets without diversification is just work, diversification is good but, buckets AND diversification are really good. Common wisdom, I know.

job

 

[cute fuzzy bunny]

I largely agree with you.

Its that word "likely" coming within a country mile of future market returns that makes me twitch a little.

 

[mathjak107]

i find using my 3 buckets works for me,alot less stress in a down market....most of us without realizing it use 3 buckets anyway but with no structure or plan as to how much to put in each..you have your short term money for income ,you have your bonds and relatively safe stuff and you have your stocks..all usually in a hodge podge...the buckets give you structure and real numbers for each bucket so it increases your odds of never selling in a down market for more income....i use 2 seven year buckets for 1 and 2 giving me 14 years of money before i have to worry about selling stocks....overall my entire mix is 25% cash 20% bonds and income reits,,,50% equities,5 % commodities  but are structured between the 3 buckets s   

 

[preben]

I have 1M buckets - I put $1 in each and and will only worry when I have used 300k buckets. Cheers!