Buckets of Money ala Ray Lucia -- please critique

[chinaco]

The strategy of holding 1-3 years of expenditures in very liquid assets (i.e. money market/short-term bond) and the balance in stocks and bonds is not new. What seems to be a twist to me is the concept of not rebalancing between the three pools of money for 7 years.

Has anyone critically studied this approach and critiqued it? On the surface it seems reasonable. But is it any better than yearly rebalancing? Has anyone done a comparison?


http://www.raylucia.com/igsbase/igstemplate.cfm?SRC=DB&SRCN=&GnavID=41&SnavID=137

 

[donheff]

I think in our previous discussion on this we concluded that the instructions on pulling funds from the buckets is not clear. I came to the conclusion that you do not leave the buckets alone for seven years unless you have to - e.g. in a prolonged bear you would spend down the cash bucket. But in a good market you would would bleed enough cash down from above to keep your cash bucket full so you could absorb the prolonged bear when it comes. Others say no, spend down the cash bucket and hope the other buckets are in good shape to replenish when 7 years is up.

 

[LOL!]

I think it is much ado about nothing. If you assume the SWR is 4% and that 4% matches your annual expenses, then having 4% to 12% of your assets in short-term reserves is hard not to do. If you have 60% equities, 40% bonds you could look at some of your bond funds and find they are 20% or more cash nowadays. You can look at your equity funds and find they are 5% cash as well.

Furthermore, even if you are in the accumulation phase, I think you will have some short-term reserves sitting around. S&P in their weekly TheOutlook has pretty consistently recommended 25% bonds, 15% cash for the last few years.

 

[modhatter]

I have played with Ray's approach a little. The only thing different about it is delegating more principal to income to give the balance a better chance of growing and not having to take money from a down portfolio.

However, when I analize it, I can't really see an absolute benifit. If into your sixth and seventh year, the market goes into a dive, and you are out of money in bucket #1, you still have to take money out of bucket #2 to replenish bucket #1 to live on - even if you are in a down market. Same thing applies to bucket 3. If you look at firecalc, and plug in any number for 15 years representing your bucket #3, there is a chance that bucket number 3 can shrink to 1/2 of it's original value, even if you don't withdraw anything from it. I know the odds of this are not great, but they are still there.

It is difficult for any of us to determine the difference in the odds with using the traditional 4% withdrawl as opposed to spending down more principal in order to have balance grow more. I guess the bottom line is, his approach probably works better if you are in an overall good market, but does not work so good if you are in an overall bad market. Or rather, neither approach works if you are in a bad 15 year market.

It would be interesting research though if we could take firecalc results and somehow plug them into this type of withdrawel method to see how you fare.

What are your opinions?

 

[Rich_by_the_Bay]

Lots of prior discussion on this. My bottom line on Lucia's approach - I like it, though it is more a convenience than anything revolutionary. It stands out mostly due to:

a) lots and lots of cash sitting around - 28% of portfolio typically, in MMF and short term bonds. Like it or not, that is where you end up if you stay true to the spirit of the plan. You sleep well.

b) you self-annuitize that cash bucket, so what seems like a lot of cash actually consumes itself over time so that allocation to cash diminishes pretty quickly and you end up with little or no cash at the end of cycle 1. This is considered OK because bucket 2 is designed for investments that don't lose value and over 7 years or so should have plenty to replenish bucket 1 with a high degree of historic success.

Realistically, you do a bit of rebalancing among the buckets (and even within the buckets esp stocks). Most of this is from stocks to bucket 2 to bucket one, and a little from bucket 2 to stocks if you want to go bargain shopping after a downturn.

c) the reason it is different is that there is a 10-15 year period of time before you even think of liquidating stocks (other than for rebalancing). For that reason, market timing is not an issue a year 15 since it pales in importance to the long term gains anticipated by then

So for me, it provides a nice, clean way to follow by money (short, intermediate and long), keeps me focused on expenses (you calculate buckets 1 and 2 by how many years COLA'd expenses you anticipate, not some percentage of total assets). It also does a controlled burn of 5-7 yrs of cash so you never really worry too much about immediate stock market performance.

No miracles, but a pretty creative way of looking at the master plan. Hope that helps.

BTW, his latest book adds little to the original buckets book. It's better written but if you have the first, save your money.

 

[ziggy29]

Lots of prior discussion on this. My bottom line on Lucia's approach - I like it, though it is more a convenience than anything revolutionary. It stands out mostly due to:

Agreed. I think it's a sound strategy, and certainly a little more detailed than the usual "percent in stocks, percent in cash" allocation. But it's really not like Lucia revolutionized the financial planning area with this concept. He certainly expanded on it and put a familiar term on it, but this strategy has been around in some form for a long time.

If you think about it, someone who only needs 1% of their retirement portfolio each year doesn't need the commonly recommended 60/40 mix. They'd probably be fine with only 10-15% of their portfolio (10-15 years of "safe" money) outside of equities for long-term growth.

Good strategy -- not something I'd pay someone a lot to implement, though. I'll probably use some variant of it when I'm approaching retirement age.

 

[youbet]

c) the reason it is different is that there is a 10-15 year period of time before you even think of liquidating stocks (other than for rebalancing).

Agreed that there is a 10 - 15 year period of time before you even think of liquidating stocks (other than for rebalancing). Disagree that this is "different." Rather, it is an extremely common approach.

 

[Rich_by_the_Bay]

Agreed that there is a 10 - 15 year period of time before you even think of liquidating stocks (other than for rebalancing). Disagree that this is "different." Rather, it is an extremely common approach.

No argument with that. What I meant and should have said in answer to the OP's comment, is that if you wait 12-15 years, catching the market in a down time in order to replenish your buckets 1 and 2 is much less of a threat than it would be if you had to dip into it repeatedly over that preceding 15 years. At least historically, that type of interval should smooth out a lot of volatility, relatively speaking.

I doubt I will literally ignore my bucket 3, but rather than "manage" it, I'll probably do some gentle rebalancing from bucket 2 once every so often when the stars are aligned. Mostly leave it alone, though.

 

[donheff]

Lots of prior discussion on this. My bottom line on Lucia's approach - I like it, though it is more a convenience than anything revolutionary. It stands out mostly due to:

a) lots and lots of cash sitting around - 28% of portfolio typically, in MMF and short term bonds. Like it or not, that is where you end up if you stay true to the spirit of the plan. You sleep well.

b) you self-annuitize that cash bucket, so what seems like a lot of cash actually consumes itself over time so that allocation to cash diminishes pretty quickly and you end up with little or no cash at the end of cycle 1. This is considered OK because bucket 2 is designed for investments that don't lose value and over 7 years or so should have plenty to replenish bucket 1 with a high degree of historic success.

Rich -- this sounds like you would spend down the cash even if the market is booming. Is that true? If so, what happens if the market crashes 40% just when you are spending your last dollar of cash? Now you would have to sell in a down market to generate cash to refill the buckets.

I interpreted the concept to be one of maintaining a substantial cash reserve that would be used only in bad markets. During good markets you would "drip" equity improvements into the income stream. Thus whenever the down period sets in you would have 7 years of cash to tide you over until things bump back up.

 

[Rich_by_the_Bay]

Rich -- this sounds like you would spend down the cash even if the market is booming. Is that true? If so, what happens if the market crashes 40% just when you are spending your last dollar of cash? Now you would have to sell in a down market to generate cash to refill the buckets.

Don, you self-annuitize the cash in bucket 1. That takes, say, 7 years. That is historically long enough to allow the bucket 2 investments (by their nature, e.g. intermed bonds, etc.) to supply the next 7 years with low risk of loss over that duration. By then your stocks have been untouched over a period long enough to have largely neutralized volatility risk (historically backtested).

14 years of average growth (e.g. 10%, perhaps a bit less) will have doubled your bucket 3 investment. A 40% doomsday hit at that moment in time would obviously be a bad thing for everyone, but even that would be against the backdrop of a prettty big nest egg 14 years into retirement, with SS, etc. all well in place and the biggest expense years probably behind you. Short of a doomsday scenario, you'd be in pretty good shape.

During the first 14 years, you would be rebalancing your buckets in a specific way. If you're gonna talk about a 40% drop, you also have to assume a 40% gain somewhere in there. That money gets partially pruned into Bucket 2 to partially replenish your purchasing power and/or from B2 to B1 to buy even further peace of mind, so that you could sustain an even longer drought without having to sell low. I've twisted this thing inside out a number of times and with a little improvisation and sticking to a 4-4.25% SWR, it works for me. It's not infallible but it would take monumental bad times to break it if it's built right and expenses are monitored.

Lucia does not do a good job of explaining how you rebalance among buckets. He seems to think that only a financial advisor should tackle such challanges . But if you read between the lines (esp in his latest book), it's stuff most of us here can do easily.

Hope that's helpful.

P.S. I like the idea of sliding into FIRE with a bundle of cash in my portfolio so I'm immune to the dreaded early bear market syndrome; if the bear stays away, it gives me even more time and money to play with, but if it happens I'm not needing to sell low and early.

 

[audreyh1]

I interpreted the concept to be one of maintaining a substantial cash reserve that would be used only in bad markets. During good markets you would "drip" equity improvements into the income stream. Thus whenever the down period sets in you would have 7 years of cash to tide you over until things bump back up.

Yeah that's the only thing that makes sense to me too. As long as equities are doing well, you keep replenishing your 7 year cash reserve. Then when equities do poorly, you start dipping into your 7 year cash reserve until equities recover (hopefully within 7 years).

Audrey

 

[Rich_by_the_Bay]

Yeah that's the only thing that makes sense to me too. As long as equities are doing well, you keep replenishing your 7 year cash reserve. Then when equities do poorly, you start dipping into your 7 year cash reserve until equities recover (hopefully within 7 years).

Just another way to look at.

Under Lucia's plan you don't use the proceeds from stock earnings to fund immediate expense directly, at least in the official version. The theory is that by sticking with your cash through thick and thin times in the market you remove the volatility risk from your stock portfolio.

What you "can" do during good markets is add to your bucket 2 through rebalancing (as opposed to putting it directly into your bucket 1); this gives you more depth, staying power, and additional ability to bargain hunt during disaster sales in the market. But you pass it through bucket 2 if it's coming from bucket 3; you keep it out of your piggy bank.

My take is that by relying only on your bucket 1 for expenses and income, you are more apt to be patient with your longer term money. It's the same idea but adds distance between your stock earnings and losses and your ability to meet monthly expenses.

Much of this is semantic. I hear what you are saying and have no quibble with it, but the buckets really do help me maintain good "money hygeine" (think long for stocks, have plenty of reliable buffer for expenses and downturns, don't be forced to sell low, avoid overdrive selling during good times, etc.).