AA vs Buckets during the bridge to SoSec

[samclem]

Regarding Kitces, he is a smart guy but all his article proves is that if you rebalance every year then your results are the same as those of someone who rebalances every year. QED.

FWIW, he does address the case where an investor sticks with the "buckets" and does not rebalance annually:

In fact, the chart below shows the results of just using the decision-rules approach without rebalancing along the way. As the results reveal, it is worse – so much worse, that the portfolio barely has anything left at the end with the decision rules alone, while the outcome is drastically better with rebalancing because it actually buys equities during dips!

In other words, not only are the decision rules actually irrelevant once the portfolio is regularly rebalanced, but eliminating the rebalancing is so damaging that the decision rules alone actually lead to a worse outcome for the portfolio!

(Note the scale of the Y-axis of the charts is not the same).
He goes on to explain why this happens: not buying equities as the decline happens hurts later recovery a lot. OTOH, if a person believes they can predict how long a future downturn can last and wants to try to size the buckets accordingly--I wish them good luck.


I can understand the desire to have a safe, stable bridge to the eventual SS checks. If this were important to me from a sleep-at-night perspective, I would probably favor the approach suggested by Independent:

Why do you "need" to have money in stocks to outpace 4, 7, 9, or 12 years of inflation?
In theory, laddered TIPS will stay even with inflation, why wouldn't that be good enough for this time period?

Some people have also mentioned that they will coordinate their SS benefit start to the market: if the market heads down after they are eligible for SS, they will start their checks in order to reduce the spending from their equities while their share prices are beaten down, which may help them recover faster when the market rebounds. But if equities climb, they'll delay starting their SS checks and benefit from the higher checks and greater longevity insurance, taking a little of the sting out of things when the equities do eventually fall.

 

[Ed B]

Ed B,
As you've already done some background reading, you may have already read this article by Kitces. If not, I highly recommend it, it clarified a lot of things for me. I found that the comments and answers after the main article were also worth reading. Your question in the OP, as I read it, is how best to use buckets to address sequence of returns risk in your first years of retirement, and this is exactly what Kitces covers in the linked article.

Bottom line (and slight generalization): If you are in the withdrawal phase and plan to set an asset allocation and rebalance to it on a regular basis (which is a very good idea), then common bucket strategies have zero impact. It may have some psychological benefit, but it does not reduce risk in comparison to simple rebalancing without the artifice of "buckets."
If you don't plan to automatically rebalance your portfolio across asset classes when they get out of whack (buckets or no buckets), then that's worth a separate discussion, and the topic will be "the sad and sordid history of market timers."

Samclem,

I have read it but I am the type that benefits from reading things again and again.

As I see my situation, the bucket metaphor seems to fit my situation until I start SS partly because the money will be at two institutions for a part of that time. Equities at vangaurd (in a few days). Fixed income at megacorp 401k with Voya. Once I go through the "bucket" left with Voya, then both will be at vangaurd but my mental picture will be more or less the same. Once I start SS my mental approach changes. At that point I plan to return to orthodoxy and go with an AA I am comfortable with for the remainder of retirement.

I am writing this before reading the Kitces article again.

Thanks
Ed B

 

[Independent]

I thought I'd use FireCalc to do some numbers regarding the narrow question of using a fixed income bucket only during the bridge period. (That seemed to be the OP question.)

I think it told me there is a very small advantage in the bucket strategy.

I told FireCalc I had a $1,000,000 portfolio and a $40,000 SS benefit starting in 2022. I asked for a maximum total income with a 95% confidence level. It gave me $73,267.
Presumably, that meant it thought I could withdraw $73,267 from my portfolio annually for the first 4 years, and $33,267 thereafter.

Then I told FireCalc I had a $840,000 portfolio and an immediate $40,000 SS benefit.
Again, I asked for a maximum total income with a 95% confidence level. It gave me $73,389.

FireCalc didn't know this, but the second run was similar to the first, except that I carved $160,000 out of my initial portfolio, invested it in assets that yielded exactly the rate of inflation, then withdrew $40,000 each year from that side fund each year, and called it "Social Security" income in the FireCalc input.

The results tell me that the second strategy, the bridge bucket, increased my total income by 0.17%. Presumably, there was one down scenario where it was better to pull some money off the table.

 

[samclem]

I thought I'd use FireCalc to do some numbers regarding the narrow question of using a fixed income bucket only during the bridge period. (That seemed to be the OP question.)

Thanks, that's very useful.

The results tell me that the second strategy, the bridge bucket, increased my total income by 0.17%. Presumably, there was one down scenario where it was better to pull some money off the table.

Do you happen to have the data still available? Your results give us info on the lower-side of things (withdrawal level for a 95% survival). Do you have data for avg final portfolio balance or other metric so we can get some idea of the opportunity cost of the "draw first from the cash bucket" approach vs "draw from the entire AA" approach?

 

[corn18]

While I concede that there are different interpretations of buckets.... what I was thinking of is based on Christine Benz's writings.... https://www.morningstar.com/articles/714223/the-bucket-approach-to-retirement-allocation.html .... which has 3 buckets rather than 2.

Bucket 1 is cash.... "to meet near-term living expenses for one year or more"
Bucket 2 is "five or more years worth of living expenses, with a goal of income production and stability"
Bucket 3 is "is dominated by stocks and more volatile bond types such as junk bonds"

For me this roughtly correlates with my 60/35/5 AA and I find AA easier to use so I focus on AA and rebalance. Luckily, in the 7 years that I have been retired my equity portfolio has never been severly under target so I've never had to make the decision of whether to either stand pat or sell bonds and buy equities.

I like the simplicity of this. I am 60/35/5 and plan to remain that way forever. That way I don't have to think too hard. And I will use iORP to plan my Roth conversions. Everything else is noise.

 

[pb4uski]

I thought I'd use FireCalc to do some numbers regarding the narrow question of using a fixed income bucket only during the bridge period. (That seemed to be the OP question.)

I think it told me there is a very small advantage in the bucket strategy.

I told FireCalc I had a $1,000,000 portfolio and a $40,000 SS benefit starting in 2022. I asked for a maximum total income with a 95% confidence level. It gave me $73,267.
Presumably, that meant it thought I could withdraw $73,267 from my portfolio annually for the first 4 years, and $33,267 thereafter.

Then I told FireCalc I had a $840,000 portfolio and an immediate $40,000 SS benefit.
Again, I asked for a maximum total income with a 95% confidence level. It gave me $73,389.

FireCalc didn't know this, but the second run was similar to the first, except that I carved $160,000 out of my initial portfolio, invested it in assets that yielded exactly the rate of inflation, then withdrew $40,000 each year from that side fund each year, and called it "Social Security" income in the FireCalc input.

The results tell me that the second strategy, the bridge bucket, increased my total income by 0.17%. Presumably, there was one down scenario where it was better to pull some money off the table.

I guess that proves that the side find doesn't make a difference if the SS benefit only grows for inflation.... which seems fairly intuitive... if your retiremnt fund is 60/40 with the side fund it grades from an overall 50/50 to 60/40 over 4 years.

But... in real life, if you defer the $40k SS benefit it will be more. Let's say that the start of the analysis is at FRA of 66 and the PIA is $40k in 2018 so the benefit will be $52.8k in 2022 at age 70 ($40k*(1+(8%*4years))).

How does it work out under that scenario?

 

[samclem]

But... in real life, if you defer the $40k SS benefit it will be more. Let's say that the start of the analysis is at FRA of 66 and the PIA is $40k in 2018 so the benefit will be $52.8k in 2022 at age 70 ($40k*(1+(8%*4years))).

As I read it, the test as run by Independent isn't really a comparison of early vs late SS, it is really a comparison of:
1) Draw from total portfolio during bridge years (his first run)
2) TIPS side fund during bridge years (his second run). The SS draw was his way of simulation the TIPS (both increase at the inflation rate)


Increasing the SS checks to reflect taking SS later would have messed up the comparison.

 

[OldShooter]

... the bridge bucket, increased my total income by 0.17%. ...

How do we know that the FireCalc people have a sense of humor? They predict using decimals and provide numbers to a hundredth of one percent.

 

[pb4uski]

As I read it, the test as run by Independent isn't really a comparison of early vs late SS, it is really a comparison of:
1) Draw from total portfolio during bridge years (his first run)
2) TIPS side fund during bridge years (his second run). The SS draw was his way of simulation the TIPS (both increase at the inflation rate)


Increasing the SS checks to reflect taking SS later would have messed up the comparison.

Gotcha... like if the fact pattern was that the subject was 58 in 2018 and eligible for $40k of SS in 2022.. in that case the side fund doesn't make much difference vs just an overall AA approach other than perhaps peace of mind.

 

[Independent]

As I read it, the test as run by Independent isn't really a comparison of early vs late SS, it is really a comparison of:
1) Draw from total portfolio during bridge years (his first run)
2) TIPS side fund during bridge years (his second run). The SS draw was his way of simulation the TIPS (both increase at the inflation rate)


Increasing the SS checks to reflect taking SS later would have messed up the comparison.

Thanks, that's a good explanation.

 

[Independent]

Two reasons:

1. My portfolio isnt as large as most members of this community and 12 years of living expenses BEFORE starting SoSec would run it much lower than I am comfortable with. After I start SS, which will be a year by year decision, my withdrawal rate will be very sustainable according to FIRE-Calc I-Orp and my simple math skills.... all 100% success rate.

2. I am not impressed with TIPS. The TIPS offered in my 401k simply bleeds money. It doesn't keep up with inflation let alone beat it.

I am moving everything not designated for the bridge to age 62 to Vangaurd. The check is literally in the mail. Perhaps there are better TIP funds available but I will probably go right back to VTI with most of it.

If you've put your plan into FireCalc and got a 100% success rate, then I'm not going to second guess it.

Note my post above where I tried to model funding the bridge spending through a stable side fund vs. funding the bridge spending through the regular AA. The difference in "safe" spending was nearly invisible.

Note, also, that my post specified a TIPS ladder, not a TIPS fund.

 

[Ed B]

If you've put your plan into FireCalc and got a 100% success rate, then I'm not going to second guess it.

Note my post above where I tried to model funding the bridge spending through a stable side fund vs. funding the bridge spending through the regular AA. The difference in "safe" spending was nearly invisible.

Note, also, that my post specified a TIPS ladder, not a TIPS fund.

Thanks for the response. I did see your post on the insignificant difference between the two methods.

 

[Independent]

Thanks, that's very useful.

Do you happen to have the data still available? Your results give us info on the lower-side of things (withdrawal level for a 95% survival). Do you have data for avg final portfolio balance or other metric so we can get some idea of the opportunity cost of the "draw first from the cash bucket" approach vs "draw from the entire AA" approach?

I didn't save it, but the input required is so minimal that I could recreate it easily.

The "start with $1,000,000, SS after 4 years" has an average final balance of $1,626,378.

The "start with $840,000, SS immediately" has an average final balance of $1,570,787.

I didn't do the extra work of downloading all the individual years to see how each varied. I'd just guess that those with a sharp drop at the beginning looked better with the side fund, while the rest looked better leaving all the money in the regular AA. There are fewer "sharp drop" than "average or better" yield scenarios.


(Note, in order to see the average, I had to run without checking the "find maximum income" option, but just input the incomes I got from my earlier runs.)

 

[samclem]

I didn't save it, but the input required is so minimal that I could recreate it easily.

The "start with $1,000,000, SS after 4 years" has an average final balance of $1,626,378.

The "start with $840,000, SS immediately" has an average final balance of $1,570,787.

Thanks. So, on average, with the assumptions you made, using a cash (TIPS) bucket for 4 years before SS starts, compared to taking the spending from the larger portfolio and rebalancing:
1) The max safe spending was virtually identical ( .17% different).
2) The cash (TIPS) approach had an average terminal value about 3.4% lower than the "take from the large portfolio and rebalance) approach.



And this is for just a four year "bridge" before SS. I'd expect the gap to grow if we looked at 8 or 12 years. The effect is probably from the (expected) cash drag and the less obvious impact of not buying as many equities during market downturns since the "bucket" isn't included in the rebalancing computations.

 

[rayvt]

As luck would have it, just a few days ago I made a post (on another board) in a thread about how a cash bucket would have helped if you retired in the very bad SOR year of 1966.

Here's what I posted:
-----------
Anyway, look at the CashBucket spreadsheet I posted. https://www.dropbox.com/s/xf4ma5blug27aws/SPY_Withdraw_by_CashBucket_rules.xls
Set the start year to 1966, the SWR to 4%, and # of years in cash-bucket to 4.

With no cash bucket, the 60/40 portfolio goes to zero in 2007.
With a 4-year cash bucket, the 60/40 portfolio goes to zero in 2003.
Oops.


That's with refill strategies 3 or 4.
3 "as soon as possible, whenever there was a portfolio gain the previous year."
4 "Only when the market is higher than 2 years ago -- 2 years after a bottom."

You're actually better off with strategy 0 "Never refill the cash bucket."
That goes to zero in...2007. Exactly the same as no cash bucket at all.

Now set the start date to some other year that *isn't* a really bad time to start, like 1960. Both with & without cash bucket survive, but the non-cash bucket portfolio is was ahead of the cash bucket portfolio. Way ahead. Three times as much. $600K vs. $200K.

The mirage of the cash bucket costs you a heck of a lot of money.

 

[rayvt]

While I concede that there are different interpretations of buckets.... what I was thinking of is based on Christine Benz's writings.... https://www.morningstar.com/articles/714223/the-bucket-approach-to-retirement-allocation.html .... which has 3 buckets rather than 2.

I read her article when she wrote it. It's garbage.

Remember that semi-snarky saying about "Today is the first day of the rest of your life."?

Well, that's what her 1-year, and 5 year bucket method is. Nonsensical.

If you spend your 1 year of expenses from your #1 bucket, then on the next Jan, you don't have a "1 year" bucket anymore. It's now "next January is the first year of the rest of your life." And you need to start off with 1 year of cash, because that's your bucket-allocation strategy, right? But your #1 bucket is empty.

Same thing for the 5-year bucket. In 5 years, you are at the end of the bucket, so what now? You start a new 5-year bucket? But that's just a complicated way of rebalancing. Just like what Kitces said.

 

[Ed B]

As luck would have it, just a few days ago I made a post (on another board) in a thread about how a cash bucket would have helped if you retired in the very bad SOR year of 1966.

Here's what I posted:
-----------
Anyway, look at the CashBucket spreadsheet I posted. https://www.dropbox.com/s/xf4ma5blug27aws/SPY_Withdraw_by_CashBucket_rules.xls
Set the start year to 1966, the SWR to 4%, and # of years in cash-bucket to 4.

With no cash bucket, the 60/40 portfolio goes to zero in 2007.
With a 4-year cash bucket, the 60/40 portfolio goes to zero in 2003.
Oops.


That's with refill strategies 3 or 4.
3 "as soon as possible, whenever there was a portfolio gain the previous year."
4 "Only when the market is higher than 2 years ago -- 2 years after a bottom."

You're actually better off with strategy 0 "Never refill the cash bucket."
That goes to zero in...2007. Exactly the same as no cash bucket at all.

Now set the start date to some other year that *isn't* a really bad time to start, like 1960. Both with & without cash bucket survive, but the non-cash bucket portfolio is was ahead of the cash bucket portfolio. Way ahead. Three times as much. $600K vs. $200K.

The mirage of the cash bucket costs you a heck of a lot of money.

Thanks for that rayvt.

I appreciate all the responses and the discussion. I am abandoning the cash bucket idea for now and will keep my funds in play.

I got the rollover portion of my 401k into a Vanguard IRA yesterday and have been investing the past two days. I am settling in with a very aggressive 80/20 AA to start. The 20% being a mix of Stable Value left in the 401k and BIV in the Vangaurd IRA. Six % of my equities are in a single stock that I want to ride out a little longer. I plan to market-time the crap out of it and move it to the fixed income side after it nears my target, and it is getting there.

Right now I plan to transition to a 70/30 portfolio over the next year or two and maybe settle in on 65/35 eventually a few years later.

 

[pb4uski]

I read her article when she wrote it. It's garbage.

Remember that semi-snarky saying about "Today is the first day of the rest of your life."?

Well, that's what her 1-year, and 5 year bucket method is. Nonsensical.

If you spend your 1 year of expenses from your #1 bucket, then on the next Jan, you don't have a "1 year" bucket anymore. It's now "next January is the first year of the rest of your life." And you need to start off with 1 year of cash, because that's your bucket-allocation strategy, right? But your #1 bucket is empty.

Same thing for the 5-year bucket. In 5 years, you are at the end of the bucket, so what now? You start a new 5-year bucket? But that's just a complicated way of rebalancing. Just like what Kitces said.

You could say the same thing about a two-bucket strategy... that's the issue I have with buckets... the produre for refilling is not sufficiently defined to be useful. FWIW, my reference to her article was in response to OldShooter's comment on 3 buckets vs 2 buckets.

 

[Winemaker]

My choice was to have a cash bucket to use the first 5 years of FIRE to avoid a sequence of bad returns the first 5 years.... a hook always touted by annuity hawkers. I have not been refilling the bucket; with the intent to just adjust AA later on. Like Kitces has cited, it does reduce total return, but I chose safety for these first 5 years, over return. I am pleased so far as October will begin year 5. Cash spend has been much lower than 4% in past, just went to 4% this January, I just turned 60.

 

[ERD50]

My choice was to have a cash bucket to use the first 5 years of FIRE to avoid a sequence of bad returns the first 5 years.... a hook always touted by annuity hawkers. I have not been refilling the bucket; with the intent to just adjust AA later on. Like Kitces has cited, it does reduce total return, but I chose safety for these first 5 years, over return. I am pleased so far as October will begin year 5. Cash spend has been much lower than 4% in past, just went to 4% this January, I just turned 60.

Seems like an illusion to me.

Can't we also say that this year is the start of a possible "sequence of returns risk" in the next 5 years? Granted, there are 5 fewer years that your portfolio needs to last, but that's probably a minor effect?

-ERD50

 

[OldShooter]

This is starting to sound like a debate between believers in different religions. If the OP is not completely confused, I will be amazed. A couple of points:

1) Bucket #1 does not have to be cash. We have zero cash in ours. We hold a floating rate fund (SAMBX) for liquidity and we have some long TIPS. The risk of the SAMBX is acceptable to us.

2) To talk about a bucket strategy and a fixed AA makes no sense. A bucket strategy is an alternative to a fixed AA strategy.

OK, I"m outta here. I don't like religious debates any more than I like Ford/Chevy debates.

 

[samclem]

I am abandoning the cash bucket idea for now and will keep my funds in play.
. . . .
Right now I plan to transition to a 70/30 portfolio over the next year or two and maybe settle in on 65/35 eventually a few years later.

That sounds like a good plan. No guarantees, YMMV, etc, but I think history is in your corner.

 

[Chuckanut]

One advantage of taking SS at 70 is the extra cash that will provide a more plush cushion in a big down turn. (Is there an emoji for 'smug'?)

IMHO, the bucket theory is not perfect, but if it forces a person to apply some discipline to his/her savings and investment plans, that is probably better than the same person spending willy-nilly as though the market can only go up, Up and UP, making no provision for a downturn. IOW, a plan, even one with faults is better than no plan at all. Like my old grandpappy used to say: "Never let the perfect become the enemy of the good".

 

[samclem]

IMHO, the bucket theory is not perfect, but if it forces a person to apply some discipline to his/her savings and investment plans, that is probably better than the same person spending willy-nilly as though the market can only go up, Up and UP, making no provision for a downturn.

I agree that it is good to "what if" our plans, and if the buckets get people to do that, it is good. But the "when do I refill the cash bucket?" question is really important, and too often overlooked. It can easily leave a neophyte investor at the mercy of emotions, financial pornography, etc. Since the buckets make things more complicated and produce the same or worse risk-adjusted returns ( depending on the rebalancing rule used), it's objectively not a good approach for those same newbies. I used to be a fan, but the data changed my mind.
But, yes, if buckets are used as a tool to discuss sequence of returns risk, the nature of equity downturns, etc, then it has value. Even if implemented, it's far from the worst way to manage assets and withdrawals.

 

[Winemaker]

Seems like an illusion to me.

Can't we also say that this year is the start of a possible "sequence of returns risk" in the next 5 years? Granted, there are 5 fewer years that your portfolio needs to last, but that's probably a minor effect?

-ERD50

Isn't everything we discuss on these threads an illusion? Of our own perspectives or fears? 2 or 3 buckets? 62 or 65 to 70? Pay off, keep or arbitrage? Asset allocation?

I look at these threads on this forum, and others, as giant brainstorming sessions. Everybody throws out ideas, thoughts and premises for everyone else to examine and use or reject that idea.

In my case, I will have had a bucket for 5 years, had no sequence of return risk for 4 years, and soon at 5 years and 61 years old, I am going with the AA method.
DW will get her SS in a few years at 65 and me at 70 in 9 years 9 months, unless she has a health event. I'm pretty confident at this point we will have more money than we have life left.