Buckets of Money Strategy

[AlanS]

I recently read the book Buckets of Money by Ray Lucia and wondered what some of the forum members think of his approach to retirement withdrawals. He suggests that at the beginning of retirement you create 3 buckets from your funds available for investment. The first is to cover expenses for the first 7 years of retirement he recommends things such as immediate annuities or laddered CDs. The second bucket is for the time frame of 7 to 14 years and contains income-generating vehicles such as fixed annuities and bonds. The third bucket contains stocks and other long-term growth vehicles. The idea is to live off the safe income from bucket 1 for 7 years, then convert bucket 2 to bucket 1 for the second 7 years and after 14 years start all over using the growth from bucket 3. Assuming that your initial funds are sufficient to put quite a bit into bucket 3, it sounds like a reasonable approach. Any thoughts?

Thanks,
Alan

 

[Cut-Throat]

Yup, It sounds like asset allocation to me. A very reasonable approach!

 

[Ted]

It strikes me as an unecessarily complicated (and therefore probably less effective) alternative to the approach of considering all of your financial assets as one portfolio and periodically rebalancing them accordingly.

Having assets divided between taxable accounts and retirement accounts (as most retirees necessarily do)tends to complicate things enough already. Just yesterday (Sunday Oct 19) Jonathan Clements had a good article in the Sunday edition Wall Street Journal about how to handle the dilemma of maintaining a target asset allocation within an overall portfolio that is distributed between taxable and retirement accounts (and perhaps also distributed between the accounts of a husband and wife.)

 

[unclemick]

Complicated is right. 3 adults - 3 pensions, 1 SS(2 coming), 2-IRA, 1 401k, 3-taxable AND looking at Roth conversion for some of it.

Keeping it simple is complicated enough!

 

[haha]

Complicated is right. 3 adults -

Also sounds interesting. A three adult household, who share income? I would be interested in reading anything you might share about this. Definitely there is security in a group, as well as the opportunity to spread some expenses over a larger base.

Something I notice about the Mexican families that live here. Nobody ever seems lonesome. Always a few guys out on the patio, or fixing a car. ot typical US suburb (yet!) but it has its attractions.

Mikey

 

[haha]

Complicated is right. 3 adults -

Also sounds interesting. A three adult household, who share income? I would be interested in reading anything you might share about this. Definitely there is security in a group, as well as the opportunity to spread some expenses over a larger base.

Something I notice about the Mexican families that live here. Nobody ever seems lonesome. Always a few guys out on the patio, or fixing a car. Not a typical US suburb (yet!) but it has its attractions.

Mikey

 

[unclemick]

The old sandwich gen. widowed mom, girlfreind(for 27 years) and me - technically single - equals three. She eschewed marriage number to and felt I be apt to stay around as a boyfreind - 27 yrs. and counting. But I do get to tell her how to invest.

 

[renferme]

sounds similar to the Grangarrd Strategy created by Paul Grangarrd. Basically, split your retirement savings into two pots: (1) 50% into stocks and (2) 50% into laddered investments (10 steps or years in the ladder).
Live off the ladders while your stocks have 10 years to appreciate and grow at the average rate of, say, 9% or higher if put into index funds. He says the average of the S&P500 for the last 75 years is 11% per year (that's from 1926 to 2000). By keeping the money in stocks or funds, you have 10 years to overcome bad years. And, then after the first 10 years, you do it all over again. Seems like a pretty good theory to me.

 

[steve mcgarret]

That's an awful lot of confidence to have in the stock market!

 

[renferme]

Steve,
Grangaard's book goes into much detail analyzing every 10 year period from 1926 thru 2000 showing the reader exactly how each period performed. And the results are good! As far as the 50-50 split, it's not etched in concrete. You can make it 30-70 or 70-30 or whatever you want. But the idea, as I understand it, is that after 10 years you want more total money that you started with 10 years prior. That way, you can give yourself a 'pay increase'. And, you set up the ladders in such a way, that each year you get out more money to allow for inflation. Laddered investments are fixed income investments; his example in the book used bonds that matured in 1 thru 9 years. If you use 50-50, then 50 % goes into stocks and 50% into fixed.
Ben

 

[steve mcgarret]

Well, I'm not really arguing with Grangarrd or Lucia. I'm sure they've done their research and I haven't detailed it to death as , I hope, they have. BUT.. how about 1929-1939? Or 1973-1983? I dont think the stock market did that well expescially on a real return basis during those 10 yr periods.'

And you'd need to make enough to clear inflation and fund the next 10 yrs PLUS have enough to keep in the market to do the same thing 10 yrs hence.

In fact I did something like this after having read a Scott Burns article called "The Omega Portfolio". Yes, it worked. But some runs left the remaining "dry powder" very thin. And since the future can't be relied upon to be JUST like the past, it was just too scary to "allocate-buy-hold-rebucket-rinse-repeat" . But yes, the basic premise was encouraging and appealed to my own tendency towards simplcity and "fewer moving parts". But , alas, I still feel it's a little too subject to the whims of fate and reality will require more baby-sitting of funds

 

[renferme]

Of course there were 10 year periods that did poorly.
The worst 10 year period did a -.9% ; that's 9/10's of 1 percent negative. Only 3 periods were negative. The vast majority did > 6%. Investing the the stock market is risky, but the biggest risk is inflation. Sure it's scary, but read the book ! I'm very soon to retire myself and this philosophy, if I implement, will require me to become more aggressive than I've been the past 3 years. We'll see if I can put my money where Grangaard's Strategy is.

 

[Theo]

There was actually a 18.7% deflation from 1929 to 1939, so I'm not sure keeping your investments in pace with inflation was really one of the major concerns (or all that desirable) that decade.

Theo

 

[AlanS]

I believe that Lucias method is more conservative than Grangarrds since you do not get to Lucias third bucket where the stocks are for 14 years. Using Lucias method, I would be putting about 60 percent in the stock bucket and hopefully just watching it grow. Nearly all of my funds are in pretax accounts so I will not be involved in tax balancing. Thanks for the good feedback on my original question. The method still feels basically pretty good.

Alan

 

[renferme]

Grangaard's strategy allows for the flexibility of increasing or decreasing the number of years in the ladders, but he thinks that 10 years is the optimum.

If I use his method, part of my ladder will be income paying stocks, even though he wants fixed securities in the ladders.

The scary part for me is, say I use his 50-50 example, putting 50% into stocks for the stock part of the system.
For that part of the system, I would be using my 401k.
So the money would be in Vanguard funds, probably the Institutional Index and Windsor funds. Could also use their Explorer fund, but have never liked it.
I have control over my income paying stocks, but have no control over the Vanguard funds.

Would like to read Lucia's book, but it's $30 !!! Maybe the library has it.

 

[Ted]

Any plan that commits a person to a particular asset allocation for an arbitrary number of years (be it 10 or whatever) is a gimmick that has much less chance of supporting a predictable withdrawl rate than periodic rebalancing between stocks and bonds. The first approach relies too rigidly on past market performance; the second also relies on past market performance as a guide, but provides more flexibility in adjusting to future market performance.

 

[renferme]

Ted, Enlighten me more, i guess i'm just stupid. are you criticising the Grangaard Strategy ? Are you saying that you cannot rebalance ? But, you CAN rebalance inside the stock portion of your savings. Of course the ladder portion should not be re-balanced as it contains, in his example, bonds that have been purchased to mature each year of the ladder. You live for 10 years on the matured bonds and the interest from the bonds that have yet to be matured. That way, you have 10 years (more or less depending on how you set it up) for the stock half of the plan to work for you (hopefully in a positive manner). The stocks portion can be mutual funds or stocks themselves.

I'm looking for some understandable reasons why this system is not good.

 

[renferme]

more of my previous reply:

suppose a person had retired in 2000 with a portfolio of 60% stocks and 40% bonds, 300000 in stocks , and decided to withdraw 5% per year of the previous year ending balance.
After the first year, he withdraws 15000 and the market goes down 20 %. Now he has about 228000.
Second year, he withdraws 5% or 11400 and the market goes down another 20%. Now he has 173280.
Then third year (2002) he withdraws 8664 and the market goes down another 20%. Now he has 131692.
Wow, what a loss of income and his portfolio value is now next to nothing. He will never recover and has to un-retire !

But, if the 300000 was in stock using the Grangaard System, he would not be tapping directly into stocks.
He would be living off the ladder portion of the system.
So, after the first year, the value of his stock portfolio would be 240000, after the 2nd year 192000, and after the 3rd year 153600.

That's 21,908 more ! And since no money is taken out of the Grangaard stock portion, he has 7 years to recover. Assuming a 20% rise for 2003, he would be up to 184,320 at the end of year 2003. That's opposed to 150128 for the other example.

 

[Bob_Smith]

Hi bennevis,

Have you checked Gummy's site? I haven't put his "Sensible Withdrawal" strategy into practice yet, but so far it makes the most sense to me:

http://home.golden.net/~pjponzo/sensible_withdrawals.htm

I haven't read the Grangarrd Strategy. Does it call for buying stocks when prices are down? If not, that could be a flaw.

 

[Ted]

Bennevis,

There are a couple of potential problems with the Graangard system, although its not necessarily "bad."
Essentially, it involves re-balancing, except that the rebalancing is done every 10 years.  During that time, a person's portfolio starts out with some fraction in (laddred) bonds that will have an average duration of about 4 years -- pretty short term which may not offer much return.  As time goes by, the entire portfolio shifts to stocks, such that in 10 years the person has to liquidate a large amount of stock and incur possible higher taxes as the result.

If I were going to use that plan, a couple of things that I would do would be (1) use TIPs for the "laddered bonds" to protect against possible inflation during the first 10 years and (2) include some bonds, REITs, and/or high yield bond funds with the stock portion of the portfolio, and if the stock values rise, shift some of that value to those other assets.  In other words, do more of what conventional portfolio rebalancing would have you do.

If you want to really compare these approaches, you can't selectively pick a period when stocks were at a peak at the start and then crashed.  You also need to consider other scenarios like the inflation and stock market underperfomance of the 1970's. In fact, you had best carry the analysis into the following 15 or 20 years to see what would happen then.

 

[ats5g]

I'm going to take issue with Grangaard's statement that only 3 ten-year periods of stock return were negative. By my numbers, there were 8 ten-year periods when REAL "stock" returns were negative, 8 out of 68, from 1926 to 2002. There were 30 ten-year periods (out the 68 ten-year periods) when the REAL "stock" returns did not double your money. And then there were 38 ten-year periods when the REAL "stock" returns did double or more than double your money.

Remember to think in terms of Total Returns, not annualized or average returns. So, if someone gives you 6%/year for 10 years, that's 179% in total returns. There were 23, out of 68, ten-year periods, from 1926-2002, when the total REAL stock returns were less than this. 23/68 = 34%. 66% is not really the vast majority of 10-year time periods, is it?

I used the Wilshire 5000 as a proxy for "stocks". If you use the S&P 500, you get almost the same thing. With the S&P 500, there were 7-ten year periods with negative real returns, 33-ten year periods, out of 68, when the real stock returns did not double your money, and 25-ten year periods, out of 68, when the real total returns were less than 179%.

As for having more total money than you started with 10 years prior (in REAL terms so you can keep your withdrawals inflation adjusted), you pretty much have to double your stock money, in real terms, if your portfolio is 50/50. This is assuming you spend the 50% bonds in the previous 10 years. With equity returns most likely going to be lower in the future, I seriously doubt that this is likely to happen. So, it's probably good to keep your withdrawal % down to 4% and under.

Now, having said that, I think the "bucket" idea is a very good one. Though, I do have a problem with the way the portfolio is rebalanced. Assuming you let the stocks ride for 10 years, and don't rebalance, at the end of the tenth year, you have 0% in cash/bonds and 100% in stocks. As time progresses towards the tenth year, your portfolio becomes more and more concentrated in stocks. That doesn't really make me feel very comfortable.

I'd rather use a modified version of the "buckets" and withdraw from the bond/cash portion of the portfolio when stocks are not doing well (like a bear market), and then take withdrawals from the stock portion when the stock market is doing well. You can still protect your stocks (and not reverse- DCA) in bear markets this way. Frank Armstrong explains it better:

http://www.investorsolutions.com/Premier/premiercontent/files/Investing during retirement.pdf

Did the Grangaard book take the strategy and extend it to subsequent 10-year periods? For example, start in in years 1926, 27, 28,...,1972, 1973:

(1) Spend the bond portion totally within each ten years, then
(2) Replenish the bond portion from the stock portion, then
(3) Let the remaining stock portion grow for the next ten years, then
(4) Replenish the bond portion from the stock portion, then
(5) Let the remaining stock portion grow for the next ten years,
(6) and so on for 30 or 40 years for each starting year.

I tried a simulation spreadsheet for a 5% withdrawal rate, and got pretty bad results after 30 years of retirement. For 30 years, I got 24 successes and 24 failures. For 40 years, it was about half and half again. 4% did better, but still 13 failures (ran out of money) at 30 years.

- Alec

 

[Ted]

Hey, Alec

Thanks for confirming my suspicions about the limitations of the Grangaard approach.

 

[Lawrence of Suburbia]

(Apologies if anyone feels this one's been done to death...)

So, who here's retiring on the Lucia "buckets of money" plan? How's it working?

(I'm on teacups of money now, but working towards pints of it. )

 

[Rich_by_the_Bay]

Not retired yet, but poised and ready with a 3 bucket portfolio.

I have modified the strategy to better suit my needs and values. In "pure Lucia mode" you would draw down all of buckets 1 and 2 in sequence leaving yourself very heavily in stocks at an older age, then do the mother-of-all rebalancing 14 years from now. Historically that's fine and you'd probably do well.

I'd rather not do quite so well but sleep better at night. So I plan a light rebalancing during good years. Ray would prefer that you not do that very much, and that you have a chunk of non-traded REITs to assure cash flow even when stocks are down. I'll pass on the non-traded REITs and keep my allocations closer to their original numbers. I also plan take 4.5% ot total assets each year (rather than inflation-adjusted 4%), with a 95% of last year's SWR as floor, per Clyatt's recommendation.

Nothing magical here, and it's similar to Armstrong's method though he uses 2 buckets.

 

[adanna3308]

I like the general approach to a grangaard 2 bucket approach. I see 2 big problems. 10 yrs is arbitrary and at the end you have much too much in stocks. I think you have to consider the amount of income you need vs the amount you have to invest. You should invest no more in stocks than you need to in order to meet your inflation adjusted income needs over your lifetime plus your desire to leave something to your heirs. This could mean that you invest heavily in 5 yr laddered CD's. When your 70.5 you can start drawing out of your stock funds if they are substantially higher. Otherwise use the CD money and wait until the time right.