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New bucket approach
Old 06-03-2007, 03:32 PM   #1
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New bucket approach

Lets just assume that in addition to social security, you need another $30,000 in todays dollars to supplement your retirement. Now lets also say that you are interested in "growing" your retirement money with the intent to pass this money onto your heirs. And the last assumption is that your current nest egg is $1,500,000.

In bucket #1
Time 5 yrs.
CD Ladder
Income $30,000

In bucket #2
(average 6%)
Some med term bonds, maybe reits, preferreds, and some Div stock funds like DVY.

In bucket # 3
A balanced mix of stocks both domestic and international along with some commodities.

You do not increase your draw of $30,000 for five years, but at the end of 5 years, you increase Bucket#1 to $600,000 (taking $100,000) from bucket #2 that has now grown to $650,000+, thus increasing your yearly income to $36,000 from bucket #1.

At the end of the next five years, bucket #2 has grown from $550,000 to $725,000, so you take once again $100,000 from bucket #2, leaving a new balance of 625,000 in it and add it to bucket #1 to total $700,000, which will now generate a yearly income of $42,000.

Repeat the above for another 10 year period, and my quick calculations come out something like this at the end of 20 years.

Bucket #1 Balance

Bucket #2 (averaging 6%)

Bucket #3 (averaging 7.5%)

End of 20 Years
Total Balance $4,149,525
Yearly Income: $66,000.

As a final note. The big flaw in this analogy is income taxes. With so much money in CD's and income producing vehicles, the tax bite would eat up too much of that needed $30,000 income in fed. income taxes-so a greater draw than $30,000 would be needed.
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Old 06-07-2007, 07:29 PM   #2
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Assuming taxable portfolio balance in year 1 is 1.5 million @ 6% interest = $90,000. If this is considered all LT capital gains @ 15% = $13,500 in taxes before deductions/exemptions. Can you get that $13,500 k close to zero, if so how would you do it. Since $90kinterest - 30k living expense - 13,500k tax = $46,500 left to roll over to buckets II and III for growth.
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Old 06-08-2007, 07:10 AM   #3
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$30,000 income at 4% SWR suggests only $750,000 is needed. The portfolio above is twice as big.

I might suggest tweaking it with the following idea:

take the CD portion, and put around 3 years income ($90,000) in CDs. As the CD's mature, spend them as cash. Then put another $90,000 in TIPs, I-BONDS or something indexed directly to inflation. Take the yearly balance from this, divide by 3, and purchase a new 3 year CD.

$180,000 is tied up in cash. Then put the remaining $1.32 M in a 60-40 type portfolio, heavily weighted toward dividend paying stocks. A 3% yield on this would be $39k. The likelihood you would need to withdraw principle is minimal for first 15 years. Use the 39k yield to replenish the I-bond sold each year. In an up year, buy 2 I bonds, in a down year do not buy one (do not sell at a low).

Another idea would be to live off dividends entirely. 30k can be generated with a 3% yield on a $1 M portfolio. Put the other $500,000 into I-bonds, CDs and bonds. The 3% yield is much closer to being accurate long term than a 6% return on a CD.

It should be noted that you have CD ladder generating 6% per year, and that is not likely. 6% for a CD is a GREAT yield, I think 3-4% is more typical, on average, over 30 year periods.
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Old 06-08-2007, 07:54 AM   #4
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Thanks for your reply's. I have been weighing safety (lots more income) vrs. stocks and the tax man. Taking the real safe approach with lots of income maketh the tax man a very happy camper. Really need to do a side by side what if scenerio on excel. All money unfortunately will be in taxed account. No 401 K's etc. Having so much income makes my taxes much bigger and therefore would need closer to $40,000 ($24,000 for me and at least $16,000 for Mr. Taxman) Why can't they just leave us alone when we retire? Don't we all wish.
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Old 06-08-2007, 08:13 AM   #5
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I only give up about 0.5% of my total portfolio (taxable) on average to the nasty taxman. And some would consider that to be a little high. I am in a no income tax state, so that helps some. The portfolio is something like 57% equities, 43% bonds/cash.

On a $1.5M portfolio, this would translate to $7500 in taxes.

I don't see how you expect $16K to go to taxes. That's 1.07% of your total portfolio - way too high.

Are you forgetting about basis for capital gains? Or that you might be able to garner your income mostly from distributions, some of which will be taxed at the 15% rate?

But definitely taxes is a very good reason to have a large chunk of a taxable portfolio in equity investments. Hopefully you'll have this portfolio for a very, very long time, and time is in your favor. If you use buckets for a few years worth of living expenses, and NOT to generate income, you can afford to let a good portion of your portfolio fluctuate.

Another really important reason to not focus on yield or income but rather focus on total return is inflation. A income producing portfolio doesn't stand up well to inflation in the long run.

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Old 06-08-2007, 10:41 AM   #6
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The Bucket Theory is targeted to people in or near retirement and in my view is designed to provide income security while setting enough aside for growth to offset the impact of inflation. There are a lot of retirees who just move 100% to bonds in retirement (none of us would, of course), others who want to make up for their poor savings by aggressive investing. Buckets create balance. Is it the end-all of theories? I don't think so, but it is a process that works for many. Remember, in retirement it isn't about winning in the investment game, it is all about not loosing.

Most of us have a significant % of our retirement assets in IRAs so the tax bite is driven by required minimum withdrawals. If I were to plan to use investments both in IRAs and in taxable accounts I would use Bucket 3 for the taxable investments because these would be growth in character and when traded most likely to produce long term capital gains or losses.

We have a high % of our investments in two highly regarded balanced funds. They are my Steady Edies, but I can't peel away just the bond portion when I sell them if I need income. To be honest I am not fully implementing the Bucket theory because I adore my balanced funds. So I fudge a bit and can take more risk in Bucket 3.

I constructed a formula that helps me see how the 'Bucket' theory works. I can enter my own assumptions about inflation and returns. I am pasting it here, the number values are placeholders:

Withdrawal rate: 4.00%
Investable $: $1,000.00
Annual withdrawal: Investable*WithdrawalRate
Monthly Withdrawal: AnnualWithdrawal/12

Bucket 1 (Empty before 2):
# yrs safe: 7
Return % for Bucket 1: 4.50%
Factor: 1/(((Bkt1Return/12)*(1+(Bkt1Return/12))^(Bkt1Yrs*12))/((1+(Bkt1Return/12))^(Bkt1Yrs*12)-1))
Funds needed for Bucket 1: Bucket1Factor*MonthlyWithdrawal

Bucket 2 Calc:
Inflation rate: 3.40%
Factor for inflation: (1+InflationRate)^(TotalInvestmentCycle-Bkt1Yrs)
Inflation adj monthly withdrawal: MonthlyWithdrawal*InflationFactor
Factor using return above: 1/(((Bkt1Return/12)*(1+(Bkt1Return/12))^((TotalInvestmentCycle-Bkt1Yrs)*12))/((1+(Bkt1Return/12))^((TotalInvestmentCycle-Bkt1Yrs)*12)-1))
What you will need when 1 is empty: InflationAdjMoWithdrawal*Bucket2Factor
How much do I need to invest to meet that need?:
Return % for Bucket 2: 7.00%
Factor for return & years: (1+Bk2Return)^(TotalInvestmentCycle-Bkt1Yrs)
Funds needed for Bucket 2: NeedWhen1Empty/Factor4Return&Yrs

Bucket 3 Calc:
Left for Bucket 3: Investable-Bucket1Funds-Bucket2Funds
Return % for Bucket 3: 10.00%
Years to grow (investment cycle): 14
Factor for return & years: (1+Bkt3Return)^TotalInvestmentCycle
Expected vaule of bucket 3, end of cycle: Bucket3Investment*Bucket3Factor
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