Bucketing strategy. When to de-risk?

Superdude0499

Hello, very much leaning towards a ‘bucket’ strategy regarding my pension. Currently all in on global equities. How long before retirement would it be prudent to start shifting part of my funds into three buckets? Now? Or closer to retirement?

Bit more info…

52 now, planning to retire at 60.

With reasonably pessimistic assumptions I would hope to have 800k in pension and about 60k in ISA at retirement. In today’s money.

Initial Requirement is circa 24k Net.

Bucket 1 – 3 years cash

Bucket 2 – year 4 – 8 (balanced say 50/50) – takes me to SP (Requirement drops 10K)

Bucket 3 – Global Equities

If this has been covered to death already can someone point me to discussion.

Thanks in advance.

JohnWinder

https://www.morningstar.com/portfolios/bucket-approach-building-retirement-portfolio
https://earlyretirementnow.com/2021/09/14/bucket-strategies-swr-series-part-48/

Linton

Your bucketing strategy assumes 8 years of mixed cautious investments followed by 100% equity. Since  you are 8 years to retirement it would seem the minimum logical/consistent approach could be to steadily move to about  £72k current value cash for the first 3 years starting now and £60k current value in your chosen non-equity starting in say 3 years time and continuing for the following 8 years. The rest can simply remain in 100% equity since you are prepared to take that risk in retirement.

I don’t see much point in being much more cautious prior to retirement than you would be subsequently.

JohnWinder

Depends on how big ‘much’ is and how early ‘prior’ is. Nonetheless, a point might be that around retirement time one is most exposed to a bad sequence of returns. Well into retirement, with fewer years remaining to fund from your portfolio, a bad sequence of returns can be less hazardous, particularly if there have been some prior years of good returns. Please yourself if that seems realistic, there’s a lot of moving parts. The ‘idea’ is called a ‘bond tent’: more bonds leading up to retirement, fewer leading away towards no more funding needed.

Anonymous101

As Linton says your strategy in retirement has 7-11 years of lower volatility investments. You're already within this window from year 1 of retirement so as a minimum you should be looking to begin moving monies into these pots from your Global Equity bucket.

There is a pretty compelling argument for me that you should have the whole thing set up like that now and just be adding to the Equity part.

GazzaBloom

I really don't get the bucket strategy, if you bucket into 2 or 3 tranches cash/equities (say 25/75) or cash/bonds/equities (say 10/30/60) and draw from the cash in year 1, if you rebalance at the end of the year then I see no advantage over just simply drawing proportionally from the entire portfolio and rebalancing annually. 

Pat38493

GazzaBloom said:

I really don't get the bucket strategy, if you bucket into 2 or 3 tranches cash/equities (say 25/75) or cash/bonds/equities (say 10/30/60) and draw from the cash in year 1, if you rebalance at the end of the year then I see no advantage over just simply drawing proportionally from the entire portfolio and rebalancing annually. 

The bucket strategy is in many ways more of a psychological crutch than a real one.  A lot of people seem to find it more intuitive to understand, and it helps them sleep at night to know that they have a couple of years cash.  IFAs often use it I think because it seems to help people to ride out bad times.

Mathematically if you are rebalancing on a rigid fixed basis, you might just as well be invested in a single fund with the same mix.

The other advertised advantage of the bucket strategy is that you can make judgement calls about delaying rebalancing if "markets are down".  It's difficult to prove any benefit there as I haven't seen anyone come up with a solid rule for this that would deliver better results, but, it's probably not worse either.  

Strategy advocated to me recently was similar but
2 years cash
years 3-5 invested at one step below your normal risk appetite.
Years 6-10 invested at your normal level.
Years 11+ invested one step above.

Linton

GazzaBloom said:

I really don't get the bucket strategy, if you bucket into 2 or 3 tranches cash/equities (say 25/75) or cash/bonds/equities (say 10/30/60) and draw from the cash in year 1, if you rebalance at the end of the year then I see no advantage over just simply drawing proportionally from the entire portfolio and rebalancing annually. 

The problem with drawing down  a fixed income from an equity rich portfolio is that in a crash there is a risk that you begin to eat into the assets you will need to generate future income. A low risk bucket enables you to safely take a more stable income.

There is also the psychological aspect.  If the assets you need for basic living for the rest f your life drop by say 30% you may well get a little worried. If you know you can continue to live happily for several years a crash which may last a year or two is of much less concern.

Another alternative as you seem to imply is to drawdown less when markets crash. However there is the market timing aspect eg you will probably cut too late and not know when you can resume your former standard of living.  Also there is a view that I take very strongly is that one’s investments should be configured to best support your standard of living rather than your standard of living sacrificed for the benefit of your investments.

GazzaBloom

Delaying rebalancing or choosing not to draw from equities during a downturn is a form of market timing and requires some decisions, how far does the market have to fall before you decide to stop drawing down or rebalancing from the equities bucket to top up the lower risk bucket? when do you to resume? However, I do understand the psychological aspect, especially in a severe downturn.

Simple proportional drawdown with annual rebalancing after a years market downturn achieves the same result, the rebalance will use more of the cash/lower risk assets to buy more equities when they are down in price which is exactly when you should be buying. After a good year you sell the high priced equities to top up cash/safer assets.

At the end of the day, whichever route you take, over a multi year market cycle downturn and recovery, the facts remain the same, equities will be down and safer assets used up and the expectation is that the safer assets can be topped up through selling off the recovery growth in the equities.

The only real advantage I can see for bucketing is that it can be beneficial at the start of drawdown and protect against early poor sequence of returns but once bucket 1 is depleted, it's depleted, and you will have to sell equities to top it back up for the next downturn, so are just delaying the inevitable.

Linton

GazzaBloom said:

Delaying rebalancing or choosing not to draw from equities during a downturn is a form of market timing and requires some decisions, how far does the market have to fall before you decide to stop drawing down or rebalancing from the equities bucket to top up the lower risk bucket? when do you to resume? However, I do understand the psychological aspect, especially in a severe downturn.

Simple proportional drawdown with annual rebalancing after a years market downturn achieves the same result, the rebalance will use more of the cash/lower risk assets to buy more equities when they are down in price which is exactly when you should be buying. After a good year you sell the high priced equities to top up cash/safer assets.

At the end of the day, whichever route you take, over a multi year market cycle downturn and recovery, the facts remain the same, equities will be down and safer assets used up and the expectation is that the safer assets can be topped up through selling off the recovery growth in the equities.

The only real advantage I can see for bucketing is that it can be beneficial at the start of drawdown and protect against early poor sequence of returns but once bucket 1 is depleted, it's depleted, and you will have to sell equities to top it back up for the next downturn, so are just delaying the inevitable.

I would take a very different view of bucketing. A portfolio should be configured to meet objectives, be it long term growth, medium term stability, income vs growth etc etc. iIn the accumulation phase it is easy, something like a high value available at the date you wish to retire. That is it. Designing a portfolio for this is easy.

Retirement is a lot more complex with different priorities. You want sufficient return to ensure an acceptable standard of living. You need long term inflation matching. You are likely to want medium and short term stability of income, minimum stress and effort, flexibility for possibly large one-off purchases etc.

Designing a single portfolio to achieve all these possibly incompatible objectives would be very difficult, certainly far beyond my abilities.  So for me bucketing greatly simplifies the task, each bucket is designed to support a separate set of objectives. These are to some extent time period linked but not necessarily.

So we have 100% equity to provide long term inflation cover. A portfolio of funds to provide stable short/medium term income which together with guaranteed pension income automatically feeds a cautious close to cash portfolio from which all expenditure is taken. This ensures that expenditure can be stable despite short and medium term fluctuations in the world economy.

The only system maintenance required is the very occasional strategic transfer of money from the growth portfolio into the other two. There is no regular rebalancing between portfolios, their sizes being what they need to be to meet the their objective with any excess wealth going into the growth portfolio.

To those who worry that this would reduce overall total returns I have 2 answers….
1) By chance the overall asset allocations are not very different to those of a standard 60/40 portfolio so why would the overall returns be worse?
2) maximum overall return is not an objective but rather sufficient return to meet objectives at minimum risk. So it could be worth sacrificing growth to decrease risk.

The problem I see with a simple SWR-driven conventional single 60/40 portfolio is that the drawdown % must be severely constrained to avoid the problem of drawing down too much income from growth investments during a major but temporary crash thus reducing future growth. This has the effect that it is likely to be very inefficient - in a majority of backtesting cases you die with more money than you started as the dire circumstances you plan for do not happen. Since money is not being continually drained from growth investments this is not a significant factor for this bucket approach.

 

GazzaBloom

Linton said:

GazzaBloom said:

Delaying rebalancing or choosing not to draw from equities during a downturn is a form of market timing and requires some decisions, how far does the market have to fall before you decide to stop drawing down or rebalancing from the equities bucket to top up the lower risk bucket? when do you to resume? However, I do understand the psychological aspect, especially in a severe downturn.

Simple proportional drawdown with annual rebalancing after a years market downturn achieves the same result, the rebalance will use more of the cash/lower risk assets to buy more equities when they are down in price which is exactly when you should be buying. After a good year you sell the high priced equities to top up cash/safer assets.

At the end of the day, whichever route you take, over a multi year market cycle downturn and recovery, the facts remain the same, equities will be down and safer assets used up and the expectation is that the safer assets can be topped up through selling off the recovery growth in the equities.

The only real advantage I can see for bucketing is that it can be beneficial at the start of drawdown and protect against early poor sequence of returns but once bucket 1 is depleted, it's depleted, and you will have to sell equities to top it back up for the next downturn, so are just delaying the inevitable.

I would take a very different view of bucketing. A portfolio should be configured to meet objectives, be it long term growth, medium term stability, income vs growth etc etc. iIn the accumulation phase it is easy, something like a high value available at the date you wish to retire. That is it. Designing a portfolio for this is easy.

Retirement is a lot more complex with different priorities. You want sufficient return to ensure an acceptable standard of living. You need long term inflation matching. You are likely to want medium and short term stability of income, minimum stress and effort, flexibility for possibly large one-off purchases etc.

Designing a single portfolio to achieve all these possibly incompatible objectives would be very difficult, certainly far beyond my abilities.  So for me bucketing greatly simplifies the task, each bucket is designed to support a separate set of objectives. These are to some extent time period linked but not necessarily.

So we have 100% equity to provide long term inflation cover. A portfolio of funds to provide stable short/medium term income which together with guaranteed pension income automatically feeds a cautious close to cash portfolio from which all expenditure is taken. This ensures that expenditure can be stable despite short and medium term fluctuations in the world economy.

The only system maintenance required is the very occasional strategic transfer of money from the growth portfolio into the other two. There is no regular rebalancing between portfolios, their sizes being what they need to be to meet the their objective with any excess wealth going into the growth portfolio.

To those who worry that this would reduce overall total returns I have 2 answers….
1) By chance the overall asset allocations are not very different to those of a standard 60/40 portfolio so why would the overall returns be worse?
2) maximum overall return is not an objective but rather sufficient return to meet objectives at minimum risk. So it could be worth sacrificing growth to decrease risk.

The problem I see with a simple SWR-driven conventional single 60/40 portfolio is that the drawdown % must be severely constrained to avoid the problem of drawing down too much income from growth investments during a major but temporary crash thus reducing future growth. This has the effect that it is likely to be very inefficient - in a majority of backtesting cases you die with more money than you started as the dire circumstances you plan for do not happen. Since money is not being continually drained from growth investments this is not a significant factor for this bucket approach.

 

Yes, a very different way of looking at things and good food for thought.

What type of assets/funds would you consider to be valid for "A portfolio of funds to provide stable short/medium term income"? Bonds? Equity income funds?