Bucket Strategy Redux

[donheff]

We have had a lot of discussions on what's his name's (Burns?) bucket strategy over the years and many of us never could figure out his bucket replenishment approach. This Morningstar article states that some other guy named Evensky created the concept. The MS author offers several model bucket portfolios and links to videos from Evensky and to articles about replenishment. His conclusion from back-testing is that the strategy can work. I haven't actually followed the links since I am in a lazy mood. I am waiting for some of the more detail oriented members to weigh in with full analyses.

 

[REWahoo]

We have had a lot of discussions on what's his name's (Burns?) bucket strategy...

Ray Lucia: http://www.early-retirement.org/for...-hole-in-buckets-of-money-strategy-62896.html

 

[Animorph]

A bucket strategy is useless without a good refill strategy. Something like a short-term cash bucket that is always kept at 8% of your portfolio, for example, is simply a long-term investment in cash. I've heard that Ray Lucia was rather vague about refill strategies.

 

[mathjak107]

ray was never really explicit other than to say you have 15 years of time.

there really are two approaches. the conservative approach is refill whenever markets are up.

the more aggressive approach is wait until you are near empty giving stocks the greatest length of time to grow.

realize though you can be 85 and 90% equities that way.

 

[rayvt]

A bucket strategy is useless without a good refill strategy. Something like a short-term cash bucket that is always kept at 8% of your portfolio, for example, is simply a long-term investment in cash. I've heard that Ray Lucia was rather vague about refill strategies.

Indeed. The second reason that Cash Bucket strategy doesn't work is that there is no refill strategy that works well. The first reason is that your AA is heavy with cash.

Here's a spreadsheet I made to investigate. It has several different refill strategies. If anyone has another suggestion for refill method, I'd be happy to add it.

https://www.dropbox.com/s/xf4ma5blug27aws/SPY_Withdraw_by_CashBucket_rules.xls

After playing with it, it became clear that the only reason people write columns about the "success" of a cash-bucket is that they only look at a the first couple or three years. And the examples get hopelessly obfuscated by trying to include details of rebalancing in with the cash bucket mechanics. The recent M* article had this failing.

 

[Animorph]

Indeed. The second reason that Cash Bucket strategy doesn't work is that there is no refill strategy that works well. The first reason is that your AA is heavy with cash.

Here's a spreadsheet I made to investigate. It has several different refill strategies. If anyone has another suggestion for refill method, I'd be happy to add it.

https://www.dropbox.com/s/xf4ma5blug27aws/SPY_Withdraw_by_CashBucket_rules.xls

After playing with it, it became clear that the only reason people write columns about the "success" of a cash-bucket is that they only look at a the first couple or three years. And the examples get hopelessly obfuscated by trying to include details of rebalancing in with the cash bucket mechanics. The recent M* article had this failing.

Great, I'll play around with it.

I do have a cash bucket strategy for retirement. I raise cash for spending when my portfolio hits target levels. Pretty much that's the projected portfolio value at the start of each year. So if I sell equities for cash, it is per the retirement plan, though potentially early. If I don't hit the trigger points and don't have enough cash I sell as needed to meet expenses, basically month to month. If I have excess cash and the market is down 20% or more I'll think of buying equities.

So if the cash is a drag on my portfolio it's only because things are going well in the first place. If my portfolio is not doing well I most likely have no cash in the bucket and no drag, or maybe cash that can be reinvested. My small attempt at being a little conservative with an otherwise 100% equity portfolio.

 

[Brooks Saddle]

For what it is worth, Harold Evensky is a well respected financial planner. I've seen him quoted numerous times in Money magazine and I've seen him on Consuelo Mack's Wealthtrack series on PBS. He is also a prolific author in the CFP circles. I take what he says seriously.

 

[audreyh1]

Christine Benz over at M* has run several reasonable looking scenarios with the bucket strategy and they include replenishing, so look to her articles for some good "how to" ideas.

 

[audreyh1]

So if the cash is a drag on my portfolio it's only because things are going well in the first place. If my portfolio is not doing well I most likely have no cash in the bucket and no drag, or maybe cash that can be reinvested. My small attempt at being a little conservative with an otherwise 100% equity portfolio.

Exactly! That's why the cash is there, for the times things are NOT going well with the other investments and you can draw down the cash.

 

[rayvt]

I do have a cash bucket strategy for retirement. I raise cash for spending when my portfolio hits target levels. Pretty much that's the projected portfolio value at the start of each year. So if I sell equities for cash, it is per the retirement plan, though potentially early. If I don't hit the trigger points and don't have enough cash I sell as needed to meet expenses, basically month to month. If I have excess cash and the market is down 20% or more I'll think of buying equities.

So if the cash is a drag on my portfolio it's only because things are going well in the first place. If my portfolio is not doing well I most likely have no cash in the bucket and no drag, or maybe cash that can be reinvested.

Heh. My target level is a couple of zeros beyond my actual portfolio value , so I'll never have to concern myself about selling out mid-year.

I figured out the problem with that several years ago when some poster remarked that when his portfolio hit his targer (average) 10.5% gain, he sold out and stayed in cash for the rest of the year saying "I've made my 10.5%, so I'm sitting out the rest of the year." Dude, the reason the average is 10.5% is that some years have 20% and 35% return. If you chop off at 10.5%, then the average is *less* than 10.5%.

I'll never have excess cash to buy when the market is down, because the plan is to never have excess cash at all. A large cash balance means your asset allocation is slanted toward non-growing cash, and this anchor will drag your returns down overall.

 

[mathjak107]

according to studies bucket stratagies are more a game of the mind then work out any better .

the weight of so much cash and bonds cuts growth in the up years big time.

so it works out that even spending directly from stocks in down years still turned out better .

not many of us would have the nerve to be that heavy in equities but the fact is if we did most studies show you would still do better than the lower volatility bucket systems.

the only real danger would be getting hit hard in the first 5 years with such high equity positions.

 

[rayvt]

Christine Benz over at M* has run several reasonable looking scenarios with the bucket strategy and they include replenishing, so look to her articles for some good "how to" ideas

Um, yeah. She's had a number of articles. Re-read her articles keeping in mind "the only reason people write columns about the success of a cash-bucket is that they only look at a the first couple or three years. And the examples get hopelessly obfuscated by trying to include details of rebalancing in with the cash bucket mechanics." She was specifically the writer I had in mind when I said that. In fact, the reason I created the spreadsheet was after I read one of her articles, to try to get a feel for how it would work. I was greatly surprised that it doesn't work -- 'cause I assumed it would.

That's why the cash is there, for the times things are NOT going well with the other investments and you can draw down the cash.

Actually, no.
It has been said many many times, and many papers have been written on it, that the absolute best thing to do is to pick your asset allocation and stick to it. What a high cash allocation does is reduce your overall volatility and reduce your overall return. It's benefit is emotional, not financial.

Anyway, no matter what well respected financial planners say, or what M* columnists write -- or what some anonymous forum poster says -- the truth of the matter is determined by the numbers, not by musings or handwavings or assertions.

Download the spreadsheet and play with it, plug in whatever numbers you like, whatever asset allocation you like, try different refill strategies, etc. I sure couldn't find any combination of cash bucket rules that improved the performance, and that's using real historical data. Maybe somebody else can. If so, I'd very much like to know the parameters & rules.

 

[audreyh1]

Actually, no.
It has been said many many times, and many papers have been written on it, that the absolute best thing to do is to pick your asset allocation and stick to it. What a high cash allocation does is reduce your overall volatility and reduce your overall return. It's benefit is emotional, not financial.

The emotional benefit is huge. It has enormous financial implications. Plenty of investors fail because of the emotional side of short-term volatility.

I have an asset allocation. I stick to it. I also have at least 2 years of cash in an account separate from my retirement portfolio (my short-term fund). That helps me stick to the AA in my retirement portfolio during the really scary times.

I don't give a flying hoot whether having an extra 2 to 3 years of (after tax) expenses in ultra short term investments slightly lowers my long-term return.

BTW my AA has a 5% cash allocation as well. Always has as it's one of my asset classes. The models I ran in late 90s showed having a small cash allocation helped improve the return/volatility model versus not.

 

[aim-high]

Audrey, are you saying you have 2 years cash AND 5% cash allocation as well?

 

[Animorph]

The emotional benefit is huge. It has enormous financial implications. Plenty of investors fail because of the emotional side of short-term volatility.

I have an asset allocation. I stick to it. I also have at least 2 years of cash in an account separate from my retirement portfolio (my short-term fund). That helps me stick to the AA in my retirement portfolio during the really scary times.

I don't give a flying hoot whether having an extra 2 to 3 years of (after tax) expenses in ultra short term investments slightly lowers my long-term return.

BTW my AA has a 5% cash allocation as well. Always has as it's one of my asset classes. The models I ran in late 90s showed having a small cash allocation helped improve the return/volatility model versus not.

OK, I'll admit my target portfolio is 98% equity and 2% cash, excluding spending cash and checking minimum balance. I like the cash to help move things around and to rebalance. I can do a simultaneous buy and sell instead of having to sell first and buy later. And it covers me if I let the checking account get too small.

 

[tulak]

BTW my AA has a 5% cash allocation as well. Always has as it's one of my asset classes. The models I ran in late 90s showed having a small cash allocation helped improve the return/volatility model versus not.

Do you keep the 5% in cash or do you invest it in CDs or other short term instruments?

 

[sengsational]

... Here's a spreadsheet I made to investigate ...

Thanks for that. Although it takes some fortitude on my part to get in and analyze the spreadsheets, I like to see how the many smart people here model things in xls.

 

[mystang52]

I agree with those here that praise the benefits of the emotional side. DW is still w*rking, and her earnings combined with my 2-days per week gig are sufficient that we are not withdrawing anything, yet.
But I have a block of cash that's probably good for 5 years of supplemental withdrawals. I have a great emotional comfort from that. Whatever little additional investment return I might get is far outweighed by that all-important sleep-at-night factor. I didn't like Lucia's book, but I do like the general concept of allocated investment buckets.

 

[mathjak107]

actually the rising glide path loved by both dr wade pfau and michael kitces is kind of based on bucket theory in a way.

if you think about it your are spending down cash and bonds increasing your equity allocation as you age until eventually when you re-fill- you can be 80% equities by the time you refill.

michael and wade found entering retirement with about 30-35% equities to avoid being hurt in the first 5 years and then increasing equities by 1% a year up to 70% if you live that long had very very high success rates..

they felt that should equal the same high success rates as equities and annuities did in their studies.

they felt by the same token if you figure an annuity as paying to about age 100 an 80 year old with a 50% equity / 50% annuity mix can be 80% in equities with only a 20% pay out left in annuities until age 100.
they to are on a rising glide path.

so it really does look like increasing equities as we age may be the way to go.

 

[rayvt]

so it really does look like increasing equities as we age may be the way to go

Yes. But good luck on selling that idea to people who are so scared that they insist on keeping 5-7 years of living expenses in cash.

Try offering this strategy to them: "Start out with X years of expenses in cash, and then as the market takes a prolonged nosedive shift your investments toward 100% stocks." After they've finished beating you with a broom, inform them that that's _exactly_ what they'll be doing with their emotionally comfortable cash-bucket strategy.

By seeking the comfort of a large cash holding, they are actually putting themselves into the position they wanted to avoid --- having no cash and all stocks several years into a bear market.

 

[samclem]

By seeking the comfort of a large cash holding, they are actually putting themselves into the position they wanted to avoid --- having no cash and all stocks several years into a bear market.

Since we're guessing about what others want:
I think many would prefer exactly that: to be spending cash and not selling shares as the market goes down and thereby be out of cash (but owning more shares than if they hadn't been spending cash) several years into a bear market. Especially since most bear markets only last a few years.

From a strict computational standpoint, I agree it's probably best to not keep cash in a distinct bucket and to just mechanically rebalance when needed (which would result is proportionately less selling of stocks when their price goes down, just not as much as a "spend only cash when the market is down" approach). But, I do understand the appeal of the cash "cushion", and if it helps people (psychologically) devote a higher share to equities then I think they probably come out ahead.

 

[mathjak107]

Yes. But good luck on selling that idea to people who are so scared that they insist on keeping 5-7 years of living expenses in cash.

Try offering this strategy to them: "Start out with X years of expenses in cash, and then as the market takes a prolonged nosedive shift your investments toward 100% stocks." After they've finished beating you with a broom, inform them that that's _exactly_ what they'll be doing with their emotionally comfortable cash-bucket strategy.

By seeking the comfort of a large cash holding, they are actually putting themselves into the position they wanted to avoid --- having no cash and all stocks several years into a bear market.

first off they are starting from very low levels , remember you go in at retirement at 30-35% equities ... increasing 1% a year would still leave many at death with smaller equities positions than most here.

if you live long enough you max out at 70% equities as part of the rising glide path approach. in fact it is this method i have chosen to follow myself.

 

[audreyh1]

Do you keep the 5% in cash or do you invest it in CDs or other short term instruments?

CDs, IBonds I consider cash.

 

[audreyh1]

Audrey, are you saying you have 2 years cash AND 5% cash allocation as well?

Yes, I have 2 years cash outside my retirement portfolio set aside for my short-term spending needs and 5% allocated to cash as an asset class within the portfolio.

 

[audreyh1]

first off they are starting from very low levels , remember you go in at retirement at 30-35% equities ... increasing 1% a year would still leave many at death with smaller equities positions than most here.

if you live long enough you max out at 70% equities as part of the rising glide path approach. in fact it is this method i have chosen to follow myself.

Yep - the transition is very gradual over 3 decades, and you spend down your fixed income during the equity bear markets. And 70% equities is the long term target. Sure, still, some folks won't be comfortable with this approach.