Buckets can help you stay organized during volatility

Susan Dziubinski: Hi, I'm Susan Dziubinski for Morningstar.com. Market volatility is persisting. Could the concept of Bucketing help investors, even younger ones, better manage through the turmoil? Morningstar's director of personal finance, Christine Benz, thinks so, and she's here to discuss that with us today.

Christine, thanks for joining me today.

Christine Benz: Susan, it's great to be here.

Dziubinski: So, let's step back and discuss what the basic Bucket concept is in the first place.

Benz: I always chalk this up to Harold Evensky, the financial planner in Florida who has such a great practice and has talked about this idea of safeguarding retirees' near-term cash flow needs in true cash investments. And then, he invests the long-term portfolio in whatever way he thinks makes sense in terms of growing that portfolio. But the value of having some liquidity set aside in cash can help retirees stay the course, make peace with the volatility associated with the longer-term portfolio. In the Bucket approach that I've talked about in my Bucket portfolios on Morningstar.com, I've actually thought about a three-bucket portfolio. So, I've got a couple of years' worth of portfolio withdrawals in true cash investments, just as in Harold Evensky's original idea. And then, from there, I've stepped out on the risk spectrum. I've got a Bucket 2 that is composed mainly of high-quality short- and intermediate-term bonds. That houses another, say, eight years' worth of portfolio withdrawals. But the basic thesis is that you've built yourself a runway of 10 years' worth of portfolio withdrawals in relatively safe investments. That way, if the equity market falls and stays down for a good long time, you're not having to tap depreciated equity assets to meet your living expenses. That's the basic idea.

Dziubinski: In this recent market turbulence, how have these Bucket strategies done?

Benz: I heard from a reader recently. He thanked me and said that actually the strategy had been working really well for him. Not only have the bonds in his portfolio enjoyed a little bit of a gain--and diversification really has worked across asset classes--but importantly--and one thing I love to hear--was that he said, he and his wife just had felt a lot of peace of mind knowing that they had their near-term cash needs locked down and that they had a fairly sizable allocation to bonds as well.

Dziubinski: This is a strategy you've talked about for people who are already retired. What about people who aren't retired yet? Should they be thinking about a bucketing approach?

Benz: They may use it to inform how they position shorter-term goals. And also, I think for people who are getting close to retirement, I don't think it's too early to think about doing some pre-bucketing work. So, you don't want to start reorganizing your asset allocation on day one of retirement or even the year before retirement. You want to start thinking about ramping up your portfolio's exposure to safe securities. You don't want to overdo it. So, you don't want to be reactive in the face of the recent market volatility that we've had. But I do think that people who are within 10 years of retirement, certainly within five years of retirement, might think about setting up, say, that Bucket 2: the bucket that houses high-quality, short and intermediate-term bonds. Maybe think about putting eight to 10 years' worth of what they expect their portfolios will be in safe securities. Again, don't overdo it, but it does make sense to de-risk the portfolio a little bit. The other thing is, in addition to battening down the hatches for near-term cash flow needs, I think you may get some peace of mind by having more balance in your portfolio, having more exposure to safe securities.

Dziubinski: What about investors who maybe aren't that close, who aren't within that 10- or so year window of retirement? Should they be thinking about bucketing for a portion of their assets, too, and for what reason?

Benz: Potentially. Because many of us move through life and we have these shorter- and intermediate-term goals that come up, and we don't want to be all equities for those goals. So, for young investors, yes, hands off your retirement assets, keep them as equity-heavy as you can possibly stand. But chances are you've got some near-term cash flow needs coming up, whether you're paying for a wedding or a home down payment. You'd want to think about segregating the money that you expect to spend in the near term in a similar fashion. I think that the Bucket approach can be instructive for investors who are in that position. Same goes for parents of kids getting close to college. If you've had the money in, say, a 529 plan for a good long time, well, you've done really well, probably, so it's time to de-risk that portfolio to think about taking money off the table in stocks, moving it into safer securities to safeguard what you have managed to save.

Dziubinski: We've talked about the younger investor. We've talked about the investor who's maybe 10 or so years away. What about that investor who's sort of right on that brink of retirement? What do you say regarding bucketing for that person?

Benz: I think it's reasonable to start setting up a full-on Bucket system. And one of the reasons I say that is, the yield differential between cash and bonds today is really, really low. In fact, in some cases, you can pick up a better yield on online savings accounts than you can on a bond mutual fund. So, I think it is not such a big opportunity cost to go ahead and start doing that pre-bucketing work on your portfolio, thinking about your anticipated cash flow needs and using that to structure your portfolio's asset allocation.

Dziubinski: Christine, thank you for your time today. And as always, thank you for helping us make sense of what's going on in the market today.

Benz: Thank you, Susan.

Dziubinski: I'm Susan Dziubinski for Morningstar. Thanks for tuning in.