Bucketing strategy/ Risk ladder

RecliningInPeace

I'm very close to retirement and am adopting a bucketing strategy, or risk ladder as I prefer to call it. I have two years' net income in cash, one year's in an ETF with mostly bonds, one year's in an ETF with some bonds and the rest in 100 equity (MSCI World tracker). It is this alll equity pot that I will draw income from, primarily.

I'm sure there will be different opinions on how many years' cash to hold, how risky the other allocations are, etc., but my question is around when and how to dip into the cash holding.

Generically the advice is to use cash when equity is down, so that you don't have to sell distressed equity, but how do people approach this is in practice? For example, say my all equity pot is £x when I retire. Do I draw on cash when it drops a certain percentage? Or to a certain value?

Let's say I land on a rule to draw from the cash pot when equity has fallen 15%. What if by the first time there is a 15% drop in equity, the pot has grown to £1.3x? Do I then tolerate a drop back to £x, or stick to my rule of 15%? Do I have different plans for a 15% drop over two months versus a slower drop?

Maybe I am overthinking this, but would be glad to hear your views.

El_Torro

Since equities spend most of their time at all time highs then I think it makes sense to only draw on equities when they are at an all time high. Within reason of course, if they have just dropped 2% in the last couple of days then maybe this isn't a good enough reason to not draw down on equities.

If you take the above approach you might want to rethink how much non-equity holdings you have.

Notepad_Phil

My preference would be at start of retirement to calculate the number of units needed to satisfy your income needs, then each subsequent year sell that number of units and if needed (i.e. markets have fallen from first year) then use the cash buffer to bring it up to the desired income amount, whilst adding any excess to cash if markets are up. So if the market is down 1% then you end up taking 1% of your income as cash, if down 10% then 10% is needed from cash.

Pat38493

El_Torro said:

Since equities spend most of their time at all time highs then I think it makes sense to only draw on equities when they are at an all time high. Within reason of course, if they have just dropped 2% in the last couple of days then maybe this isn't a good enough reason to not draw down on equities.

If you take the above approach you might want to rethink how much non-equity holdings you have.

What do you think of the google AI answer? "Equities hit all-time highs surprisingly often; the S&P 500 ended months at highs about 26% of the time since 1950, and on roughly 7% of all trading days, "

From my admittedly limited experience, equities hit all time highs on way less than half of days, but, they seem to spend quite a bit of time within a percent or two down.  My thinking is more that if equities are at less than 10% drawdown from my personal highest ever value, I stick to my general rebalancing approach.

However I suspect others will say that the proximity to all time high is not relevant and they prefer to look at whether their gains in that period are sufficient for their needs.

However - there are exceptions e.g. between 2000 and 2010 when equities spent more than 10 years below their all time high.  I was looking at an interesting graph today in the Economist which showed a correlation between the shiller cape value and long term 10 year equity returns - if Shiller cape is pushing towards 40 or more (which it is for the S&P500 US equity right now), historically this often resulted in low / average negative returns in the following 10 years.  However - unfortunately it is useless for predicting returns in the next 1 year.

Linton

RecliningInPeace said:

I'm very close to retirement and am adopting a bucketing strategy, or risk ladder as I prefer to call it. I have two years' net income in cash, one year's in an ETF with mostly bonds, one year's in an ETF with some bonds and the rest in 100 equity (MSCI World tracker). It is this alll equity pot that I will draw income from, primarily.

I'm sure there will be different opinions on how many years' cash to hold, how risky the other allocations are, etc., but my question is around when and how to dip into the cash holding.

Generically the advice is to use cash when equity is down, so that you don't have to sell distressed equity, but how do people approach this is in practice? For example, say my all equity pot is £x when I retire. Do I draw on cash when it drops a certain percentage? Or to a certain value?

Let's say I land on a rule to draw from the cash pot when equity has fallen 15%. What if by the first time there is a 15% drop in equity, the pot has grown to £1.3x? Do I then tolerate a drop back to £x, or stick to my rule of 15%? Do I have different plans for a 15% drop over two months versus a slower drop?

Maybe I am overthinking this, but would be glad to hear your views.

I believe any strategy that relies on switching income streams will be difficult and potentially  counterproductive  to implement consistently. The danger is that your timing will be less than optimal only switching from investments to savings and back again too late as you need to be convinced circumstances have really changed. 

The strategy I have used for the past 20 years is
1) Maintain separate 100% equity growth, 50% equity/50% fixed interest income, and near to cash portfolios. Overall my investment allocation is about 60% equity/40% FI+cash.
2)  put all income from whatever source into the near to cash portfolio 
3) take all expenditure from the near to cash portfolio
4) Avoid selling investments for cash.  Apart from very rare rebalancing, the only times I sell investments from the growth portfolio is to increase the size of the income portfolio. So a crash should not be a problem since the cost of the investments being purchased will also have fallen. Investment income is far more stable than nvestment prices.

This strategy has been operated continuously without any need to make major short term  investment decisions such as switching income streams.

WillowLeaf

This video gives some info on retirement bucketing strategies

https://www.youtube.com/watch?v=3ASQi1IUHws

ali_bear

I do wish people would not post YouTube links without giving at least a brief explanation of what the link is taking you to. All you have to say is "This James Shack video .." 

Anyway for the rest of us who are interested in the subject but have either already seen that video, or who don't like his channel (for whatever reason that may be, I don't know, personally I like it), or don't want to click on random YouTube links, the above link takes you to a James Shack video, where he talks at length about retirement bucketing strategies. 

WillowLeaf

ali_bear said:

I do wish people would not post YouTube links without giving at least a brief explanation of what the link is taking you to. All you have to say is "This James Shack video .." 

Anyway for the rest of us who are interested in the subject but have either already seen that video, or who don't like his channel (for whatever reason that may be, I don't know, personally I like it), or don't want to click on random YouTube links, the above link takes you to a James Shack video, where he talks at length about retirement bucketing strategies. 

You mean like where I said 'This video gives some info on retirement bucketing strategies'

gm0

There are multiple methods to organise holdings by type. And apply a rule set to "what to sell" (first). And when to cut or boost income (variable income methods).  The advantage of rules is they take subjective fear out of the picture - the doomy/gloomy/boostery media consumed alongside actual current nominal values. 

The other reason they are possible is that they are testable - either with MC simulation or random returns. Or with backtest data series in past markets.  Or stress test markets.  To provide a check on "soundness" of the approach via how often it would have failed in the known past.  Which doesn't tell you if it will work.  

But can tell you that some parameters are demonstrably silly.

If you wish to learn more about this sort of parameterised thing.  And the limited gains available from care in management (there are some - but they are small comparing methods).  

Then I recommend you acquire and read Living off your money (Michael McClung).  He has his own prime harvesting method across bonds and equities.  I haven't followed it.  But I think his comparative assessment of the field and other methods is highly worthwhile. To help with FOMO. And understand the limited domain of practical risk management and optimisation

Any methods with thresholds - has magic numbers in them.  Commonly this is via training with backtesting data.  So it is unsurprising when it works with that same market data. Circular.  For the magic numbers to be less objectionable - it is helpful for the method to be shown working with other out of band (to training) data.  Afterwards.  Which supports the "well behaved" argument.  But is still not predictive of future success.  It is. What it is.

snarffie

WillowLeaf said:

ali_bear said:

I do wish people would not post YouTube links without giving at least a brief explanation of what the link is taking you to. All you have to say is "This James Shack video .." 

Anyway for the rest of us who are interested in the subject but have either already seen that video, or who don't like his channel (for whatever reason that may be, I don't know, personally I like it), or don't want to click on random YouTube links, the above link takes you to a James Shack video, where he talks at length about retirement bucketing strategies. 

You mean like where I said 'This video gives some info on retirement bucketing strategies'

I clicked on the James Shack video when it was posted a week or so ago and found it very useful.  The OPs question is something I have been puzzling over and the video was a useful guide to a potential strategy which I am leaning towards myself as it seems nice and simple to implement.

RecliningInPeace

Thank you for all the thoughts and the link to James' video (intelligent, informative and balanced view, as always). I have a fair idea now of how to proceed and will just tweak it to suit my specific circumstances.