Just a short post this week…. been travelling and only just really started to put together a topic of interest to me … Buckets !
I am confused and yet still interested enough to keep reading and looking ….
Put simply was popularised by Harold Evensky who came up with a two bucket approach . Put simply the whole strategy is about separating out progressively large lumps of cash into various buckets: one of 1-3 years needs and the rest spread over 3-7 and 7+ years.
There is a basic video on youtube showing one way of operation , but be warned, it really is naff and also examples drawing $70K from a $2.5M pot (a 2.8% withdrawal rate). I have not seen any paper suggesting that using a rate less than 3% would ever mean running out of money (in any practical sense). Still, if you don’t know, you can get the basic strategy (and that is the point – it is simple).
Fundamental concept is to feed income streams (Yields and Dividends) into a cash or withdrawal pot to draw from.
Clearly, if those streams are less than what you withdraw then some capital would have to be release also. And hear in lies the problem. No matter how you couch it, if capital needs to be released during a bear then there is a detrimental effect that may completely throw the strategy.
I have started putting a basic Excel model together to see if I could work out if there is any way it could reliably work (for me). So far the best approach I find is that releasing money (combination of capital, cash and income) during a rebalance is just as effective if not more so but its early days.
I see another problem with just feeding income streams directly into a ‘cash bucket’, and that is the compounding effect of re-investment. I spoke of this in two articles (Factors Affecting Returns & More on Compounding) and for me, re-investment of income provides higher future income as well as mitigating against market variance. Yes, it is not the same as looking at Total Return, or trying to maximise that, but I am in the position where I have enough capital so maxing growth is not my main priority right now, I want to sent up my funds later in the year to provide solid and growing income streams.
Interesting article from Javier Estrada (The Bucket Approach for Retirement: A Suboptimal Behavioral Trick? ) I found and just one phrase in the abstract tells the tale: “simple static strategies, which by definition involve periodic rebalancing, clearly outperform bucket strategies, and they do so based not just on one but on four different ways of assessing performance“
Then there is the article on AdvisorPerspectives entitled Does the Bucket Approach Destroy Wealth, that again makes the case for the inferiority of Bucket Strategies.
Michael Kites gives a real example of why a rebalancing approach works better and eliminates the need for anything other than a small cash reserve.
So why am I still giving what seems a generally agreed strategy that if not flawed, is at least suboptimal any time at all ?
Because it is simple to implement, manage, update and understand.
At what point might a bucket strategy actually be useful I wonder ?
Well, certainly not in the accumulation phase ! If I was 40 years old and having discovered the FIRE concept actively looking to retire by 50-55, I might well be looking at aggressive management and chasing Total Return. But I have stopped work and get at my pension funds in 6 months time, so maybe, just maybe, buckets have a place as part of my retirement. Although interested in finance and investment, I really don’t want it to become a job !
Evensky used a 2 bucket approach, many examples I have see use 3, but in reality, there is no limit. If I look at the activities I am planning I already see 5 or even 6 types of buckets (we could call them classes) all behaving differently and likely to have different cycles. Two for individual Shares and Bonds as I want to do some active trading (just so interesting researching individual propositions), a Further two for bundles of share and bond funds for longer term, some crowd funding platforms I have successfully used over the past 5 years and some Real Estate options… easy to see how I could arrange my buckets and perhaps take from them as growth or success dictate. The ease of it does have an attraction, but then will that just make me lazy ? Our cognitive functions start to deteriorate as we get older so will I actually have the sharp capacity I have no to keep on top of it.
Buckets look great if all you want to do is fire & Forget – set it up, pick a modest withdrawal rate, monitor annually and have enough to start with. If the goal is to live very well and accumulate wealth to pass on, then I doubt this strategy fits the bill, not least because there is no real need to consider inflation: it is all about the income stream matching the expense stream. I fear that in a 25,30,35+ year retirement, inflation will matter far greater than most appreciate. Add to that expenses (funds and platforms), and the drag could end up breaking the bucket with a severe bear.
I will continue to research and clarify bucket ideas (along with other investment strategies) as I do see the strategy as being a part of my future plans, but certainly not the whole. But this approach is not for everyone, and not if the numbers are tight. Just from what I have read and found, modest withdrawal is likely the key.