Bucketing strategy. When to de-risk?

Linton

GazzaBloom said:

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?

Here as in every other aspect of investing diversification is essential. So yes to equity income from any region where significant can be obtained, yes to corporate bonds, yes to  REITs, yes to infrastructure funds.  Anything that can support a 5% or more initial yield is open for consideration. So fixed gilts now look  very interesting though I have not bought any yet.

Bear in mind that for the income portfolio, inflation is not a factor. If inflation decreases the value of the income too far extra income funds can be bought using growth portfolio gains.

GazzaBloom

My initial plans for retirement are to have 15% (3 years of expenses) in cash/cash equivalent (MMF) and the remaining 85% in the same growth equity index funds I hold in accumulation, but not operate in 2 bucket mode, just draw proportionally and rebalance annually, rather than draw from cash solely in year 1.

I am open to exploring options and alternative strategies as the drawdown from DC pension will be front end loaded for the first 8 years until state pensions kick in and then be able to drop quite considerably, so I am exposed to an early bad sequence of returns risk. An income generating bucket isn't something I have looked into particularly as I kind of subscribe to the "dividend irrelevance" theory so have not been a fan of high dividend income equity funds or ITs. I also don't like bonds or bond funds and am glad I didn't hold any when 2022 happened.

However, looking at time bucketing isn't something I have really considered, using the cash for the first 3 years and having an 2nd bucket with 5 years of funds in that generates 5% would see me through to SPs and a smaller 3rd bucket of equity index funds is something I can explore.

JohnWinder

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

Precisely, which is why folk went on to describe less simple variable percentage withdrawal strategies, by which each yearly/2 yearly or whatever review adjusts the withdrawal percentage based on how well the portfolio has recently done and how much your life expectancy has changed.

Qyburn

GazzaBloom said:

My initial plans for retirement are to have 15% (3 years of expenses) in cash/cash equivalent (MMF) and the remaining 85% in the same growth equity index funds I hold in accumulation, but not operate in 2 bucket mode, just draw proportionally and rebalance annually, rather than draw from cash solely in year 1.

If you you'll take 15% of each years income from cash and 85% from equities, what's your plan for years when equities fall substantially (or rise)?

Bostonerimus1

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. 

I agree with you! Buckets are just a time ordered way of presenting asset allocation. I can see that they might help people thinking about cash flow and drawdown, but I find them unnecessary. People who have done very well out of them are Harold Evensky and Ray Lucia who have sold lots of books about "buckets".

ader42

My take is that having 2 buckets, 1 in cash (or a lower risk income generating investment) and 1 in equities, just means the smaller 3 year cash amount acts as a buffer to the volatility of the equities whilst obviously reducing expected returns. Ergo, same as having a “balanced risk portfolio”. 

If the equities have dropped 25% or more then take all your drawdown from pot 1, otherwise take some of your drawdown from pot 2 an when equities are back up then rebalance.

GazzaBloom

Qyburn said:

GazzaBloom said:

My initial plans for retirement are to have 15% (3 years of expenses) in cash/cash equivalent (MMF) and the remaining 85% in the same growth equity index funds I hold in accumulation, but not operate in 2 bucket mode, just draw proportionally and rebalance annually, rather than draw from cash solely in year 1.

If you you'll take 15% of each years income from cash and 85% from equities, what's your plan for years when equities fall substantially (or rise)?

Plough on with the same strategy but use Guyton's guardrails to reduce the drawdown amount taken in downturns or increase it in upswings, any excess gains could be used to increase the cash (risk-off) percentage over time as retirement rolls on.

coyrls

ader42 said:

My take is that having 2 buckets, 1 in cash (or a lower risk income generating investment) and 1 in equities, just means the smaller 3 year cash amount acts as a buffer to the volatility of the equities whilst obviously reducing expected returns. Ergo, same as having a “balanced risk portfolio”. 

If the equities have dropped 25% or more then take all your drawdown from pot 1, otherwise take some of your drawdown from pot 2 an when equities are back up then rebalance.

As others have said, in a single say 60/40 portfolio where equities have dropped 25%, income would be taken from the non equity portion as part of rebalancing and if after taking the income the portfolio was still out of balance some of the non equity portion would be used to purchase (cheaper) equities.

Linton

coyrls said:

ader42 said:

My take is that having 2 buckets, 1 in cash (or a lower risk income generating investment) and 1 in equities, just means the smaller 3 year cash amount acts as a buffer to the volatility of the equities whilst obviously reducing expected returns. Ergo, same as having a “balanced risk portfolio”. 

If the equities have dropped 25% or more then take all your drawdown from pot 1, otherwise take some of your drawdown from pot 2 an when equities are back up then rebalance.

As others have said, in a single say 60/40 portfolio where equities have dropped 25%, income would be taken from the non equity portion as part of rebalancing and if after taking the income the portfolio was still out of balance some of the non equity portion would be used to purchase (cheaper) equities.

How is that any different from holding VLS60 and just taking your drawdown as normal, ignoring the crash? The net effect is the same.

Qyburn

Isnt the idea to allow choice, draw from equities if they're doing well, from non-equities if they aren't. Whereas I assume drawing from VLS60 you will always be taking the same proportion of each.