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MARCH 23, 2016
The Bucket Approach to
Portfolio Construction
TD Ameritrade, Inc., member FINRA/SIPC. TD Ameritrade is a trademark jointly owned by
TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank.
© 2016 TD Ameritrade IP Company, Inc.
MARCH 23, 2016
Asset allocation and diversification do not eliminate the risk of experiencing investment losses.
All investments involve risks, including loss of principal.
Past performance of a security, strategy or index is no guarantee of future results or success.
Stock investments are subject certain risks such as market risk, price volatility and liquidity risk. An investment cannot be made directly in an index.
The material, views and opinions expressed in this presentation are solely those of the presenter and may not be reflective of those held by TD Ameritrade, Inc.
The webcast is provided for general information purposes only and should not be considered an individualized recommendation or advice. TD Ameritrade makes no representations or warranties with respect to the accuracy or completeness of the information provided. Examples and recommendations presented by Morningstar should not be considered a recommendation or solicitation by TD Ameritrade to purchase or sell any specific security. TD Ameritrade and Morningstar are separate, unaffiliated companies and not responsible for one another ’s products, services or policies. This presentation includes a feature that allows recording of electronic (including audio) participant-shared content. By continued participation in this session you automatically consent to such recording, and the subsequent rebroadcast of any recording.
Important Disclosures
Today’s Speaker
Christine Benz Director of personal Finance, Morningstar
Senior Columnist for Morningstar.com
Author of 30-Minute Money Solutions: A
Step-by-Step Guide to Managing Your
Finances, co-author of Morningstar Guide
to Mutual Funds: 5-Star Strategies for
Success
Served as Morningstar’s Director of Mutual
Fund Analysis
Also served as Editor of Morningstar
Mutual Funds, Morningstar FundInvestor,
and Morningstar Practical Finance
©2015 Morningstar, Inc. All rights reserved.
Christine Benz, Director of Personal Finance
Morningstar, Inc.
March 23, 2016
The Bucket Approach to Portfolio Construction
5
Part I: Why bucketing?
Part II: Sample bucket construction
Part III: Bucket maintenance
Part III: Bucket portfolios for retirement
Part IV: Bucket stress tests
Part V: Other need-to-knows about bucketing
Presentation Overview
6
In the past, investors who were aiming to fund a goal such as retirement needed only to:
Save enough
Invest in income-producing securities to deliver
a stream of income
But that formula has been called into question due to:
Low yield environment
Longevity gains that necessitate more growth
potential in the portfolio
High stock market volatility, which courts
“sequence of return risk”
Why bucketing?
7
Incredible shrinking yields: One impetus for bucketing
6-month, 1-year, 5-year CD rates from 1984-2013.
Source: Bankrate.com.
8
Yield for Barclays Aggregate Bond Index: 2.35%
Yield for Intermediate-Term Treasury Bonds: 1.35%
Yield for Intermediate Municipal Bonds: ~1.55%
Yield for Barclays 20+ Year Long-Term Treasury Index: 2.50%
Nor are yields especially encouraging for investors willing to take more interest-rate risk
9
High-Yield Bonds Emerging Markets Bond
Current Yield: ~6.5%-8% Current Yield: ~6%-7%
2008 Return: -24% 2008 Return: -26%
Bank Loan Multisector Bond Fund
Current Yield: ~5%-7% Current Yield: ~5%
2008 Return: -17% 2008 Return: -15%
Credit quality risk = higher yields, but at a price
10
Longevity necessitates greater growth potential in portfolio (i.e., stocks)
11
19 years: Average life expectancy, 65-year-old male
21 years: Average life expectancy, 65-year-old female
31%: Odds that one member of a 65 year-old-couple will live to age 95
Higher incomes correlated with longer life expectancies (better access to health care, access to better health care)
More on longevity gains
12
But stock-heavy portfolios court sequence-of-return risk
Encountering a bum market early in retirement can be deadly
13
Even a 60/40 portfolio would have dropped 35% from 2007-2009
14
Sample bucket approach: Helps investor maintain growth potential, generate cash flow without relying on income alone
Bucket 1
For: Years 1 and 2
Holds: Cash
Goal: Fund Living Expenses
Bucket 2
For: Years 3-10
Holds: Bonds, Balanced Funds
Goal: Income production, stability, inflation protection, modest growth
Bucket 3
For: Years 11 and beyond
Holds: Stock
Goal: Growth
15
Bucket approach splits the portfolio into two major pieces
Safe assets that will be used for near-term
expenditures
Assets that will earn income and/or grow over time,
albeit it with some volatility
Setting aside safe assets for near-term spending needs helps ensure stability of cash flows regardless of bond yields, stock-market environment
Also helps ensure that the investor won’t need to sell long-term securities when they’re down
Psychological benefit: Knowing that near-term income needs are secure helps investors cope with the volatility that accompanies long-term investments with higher growth potential, such as stocks
Bucketing helps solve a few of investors’ key problems
16
Method 1 (not recommended): Spend sequentially through the buckets: cash, then bonds, then stocks
Pros
Appealingly simple
Low/no maintenance
Cons
Portfolio becomes increasingly un-diversified and
aggressive
Risks associated with being left with a big bucket of
stocks at the end; might not be a good time to withdraw
Bucket maintenance: 3 (or more) ways to get it done
17
Method 2 (not recommended): Move money from one bucket to the next on a regular basis: stocks to bonds, bonds to cash Pros
Helps ensure that portfolio is being “de-risked” on an
ongoing basis
Cons
Labor intensive: Bucket maintenance = full-time job!
Systematic movement from one bucket to the next may
not make sense from an investment standpoint (e.g.,
probably don’t want to sell stocks annually)
Bucket maintenance varies: 3 (or more) ways to get it done
18
Method 3 (recommended): Regularly refill cash bucket as money is spent; be opportunistic about where it comes from: income distributions or rebalancing proceeds
Pros
Income distributions (from bonds and dividend-paying
stocks) provide a baseline of cash flows
Rebalancing/selling highly appreciated assets can help
reduce portfolio’s risk level while also meeting cash
flow needs
Cons
Requires some maintenance
Too frequent rebalancing can reduce return potential
from ascendant asset classes
Bucket maintenance varies: 3 (or more) ways to get it done
19
Retiree needs $40,000 in cash flow from $1 million portfolio to re-fill bucket 1 in 2014
60% S&P 500/40% bond portfolio yields $21,820
Portfolio also has capital return of $82,280 in 2014
Retiree’s $40,000 cash flow distribution comes from:
$21,820 in income
$18,180 from capital return
Retiree reinvests remaining $64,100 of capital return
Bucket Maintenance Example
20
Assumptions
65-year-old couple with $1.5 million portfolio
4% withdrawal rate with annual 3% inflation adjustment
($60,000 first-year withdrawal)
Anticipated time horizon: 25 years
Fairly aggressive/high risk tolerance (total portfolio is ~
50% stock/50% bonds and cash)
Sample In-Retirement Bucket Portfolios
21
Bucket 1: Liquidity Portfolio for Years 1 and 2: $120,000
$120,000 in CDs, money market accounts/funds, other cash
Bucket 2: Intermediate Portfolio for Years 3-10: $480,000
$130,0000 in Short-Term Bond Fund
$150,000 in Intermediate-Term Bond Fund
$100,000 in Inflation-Protected Bond Fund
$100,000 in Conservative-Allocation Fund (part bonds, part stocks)
Sample In-Retirement Bucket Portfolio
22
Bucket 3: Growth Portfolio for Years 11 and Beyond: $900,000
$400,000 in Dividend-Focused Equity Fund
$200,000 in Core International Fund
$100,000 in U.S. Equity Index Fund
$125,000 in Multisector Bond Fund
$75,000 in Commodities-Tracking Fund
Sample In-Retirement Bucket Portfolio
23
Money market account or fund, laddered CDs
Bank checking account or savings account
One to two years’ worth is plenty, plus a little extra to meet unanticipated expenses
Bucket 1 is not for
Bonds
Bank loan investments
Dividend-paying stocks
MLPs etc.
What goes into the all-important bucket 1?
24
Bucketing doesn’t help solve every problem, including:
Insufficient starting savings
A too high withdrawal rate
Too timid asset allocation given time horizon (e.g., if buckets 1 and 2 are the bulk of portfolio for a 30-year time horizon)
Too aggressive asset allocation (e.g., if buckets 1 and 2 are too small, may need to sell stocks from bucket 3 at an inopportune time)
25
Bucketing also gets complicated with multiple accounts
Most investors come into retirement with multiple accounts
Traditional IRAs and 401(k)s
Roth IRAs and 401(k)s
Taxable accounts Bucket approach must be overlay the account types
Use withdrawal sequencing guidelines to help position each account vis-à-vis the buckets
RMDs first
Taxable
Tax-deferred
Roth
MARCH 23, 2016
The Bucket Approach to Portfolio Construction
Up next:
Considering Options to Compliment Your
Existing Investment Strategies
TD Ameritrade, Inc., member FINRA/SIPC. TD Ameritrade is a trademark jointly owned by
TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank.
© 2016 TD Ameritrade IP Company, Inc.
MARCH 23, 2016
Asset allocation and diversification do not eliminate the risk of experiencing investment losses.
All investments involve risks, including loss of principal.
Past performance of a security, strategy or index is no guarantee of future results or success.
Stock investments are subject certain risks such as market risk, price volatility and liquidity risk. An investment cannot be made directly in an index.
The material, views and opinions expressed in this presentation are solely those of the presenter and may not be reflective of those held by TD Ameritrade, Inc.
The webcast is provided for general information purposes only and should not be considered an individualized recommendation or advice. TD Ameritrade makes no representations or warranties with respect to the accuracy or completeness of the information provided. Examples and recommendations presented by Morningstar should not be considered a recommendation or solicitation by TD Ameritrade to purchase or sell any specific security. TD Ameritrade and Morningstar are separate, unaffiliated companies and not responsible for one another ’s products, services or policies. This presentation includes a feature that allows recording of electronic (including audio) participant-shared content. By continued participation in this session you automatically consent to such recording, and the subsequent rebroadcast of any recording.
Important Disclosures
