Simplifying a Retirement Bucket Portfolio

A reader writes in, asking:

If you were developing different “buckets” for a portfolio in retirement, what funds would you use for each bucket?

For our immediate 1-3 years, I have assigned that duty to the Vanguard Ultra Short Bond Fund. It has a duration of one year, and does not have any government bonds.

Do you think that fund is too risky – both in terms of duration and in terms of risk? Should we have at least one year in money markets?

For our 3-6 year buckets, we use a variety of short term bond funds – such as the Short Term Bond Index Fund, Short Term Investment Grade Fund, and the Short Term Corporate Bond Fund.

For 6-10 years, we use a variety of funds such as the Target Retirement Fund, and Wellesley (because the stock allocation is of extra large Value stocks). Also for this category we would consider the Life Strategy Conservative Growth Fund. Of course with this group our main investment is in the Total Bond Market Fund, with the others hopefully boosting returns over time.

For more than ten years, stock funds such as the Total Stock Market Funds, Total International Stock Market Fund, and the S&P 500, with a few exotic funds to spice things up such as the REIT. This portion is relatively small, as we will allocate our retirement duties to primarily bond funds, with a few funds such as what I mentioned before in the 6-10 year period. I look at the stocks as a really long term investment in the event more money is needed, but I will do some rebalancing of that bucket to take profits and put money in when the market falls.

What would be your suggestions? How many buckets and which funds go into each bucket?

Principle number one when it comes to crafting a portfolio is that it’s the whole portfolio that matters. This is why, for instance, it rarely makes sense to look at one account in isolation. And it is why the overall portfolio allocation is the important question here — both what allocation you want now, and how/if you want that allocation to change over time (i.e., your intended glide path).

Bucket strategies are psychological tools, not financial ones. That is, a bucket strategy can be helpful if:

1. It helps you to arrive at an overall allocation (and glide path) that you’re happy with, or
2. It helps you to stick with your overall allocation (and glide path).

For example, some people may find that the easiest way to settle on an allocation is to think of it in terms of buckets (e.g., “I want 3 years in short-term bonds, 7 years in intermediate term bonds, 15 years in stocks”).

And some people may find that having a bucketing strategy helps them to feel more comfortable sticking with the plan during a bear market (e.g., “I don’t have to worry about my stocks going down, because I have X years worth of spending in short-term bonds and Y years in intermediate term bonds”).

And some people may find that a bucket strategy may be the most intuitive way for them to implement a desired glide path. For instance, if you like the idea of a “rising equity” glide path (i.e., one in which your stock allocation rises over time, as suggested by Wade Pfau and Michael Kitces here), you might find that the most intuitive way to implement that glide path is via a bucket strategy in which you do not “refill” the shorter-term (bond-heavy) buckets (by selling stocks and buying bonds) as they get depleted over time.

But if you find that managing/crafting a bucket-based portfolio is harder than just focusing on the overall allocation, then it’s best to forget about the buckets.

What you’re describing sounds to me like it may be more funds and complexity than is necessary. Maybe that’s because of the buckets; maybe not.

For instance, you asked whether the Vanguard Ultra Short Bond Fund is too risky, and whether the portfolio should have at least one year in money markets. My questions there would be: how much of the portfolio is in the Ultra-Short Bond Fund? And how much would the portfolio’s overall volatility be affected by moving part of that money into a money market fund? (My guess would be “a relatively small portion” and “hardly at all.”)

And with regard to what you consider the 3-6 year bucket, what is the specific advantage (to the overall portfolio) of having three different short-term bond funds rather than just one?

Or more broadly I might ask, can you achieve the overall risk profile that you want using just a few funds (e.g., Total Stock, Total International Stock, Total Bond)? If not, why not? What specifically do you feel would be missing? (Alternatively, what do you feel that you’d have too much of?) And how could you fill that gap in as simple a way as possible?

For instance, if you like the idea of a larger helping of short-term bonds than you’d have with the Total Bond Market Fund, what about those three funds, plus a short-term bond fund? Would anything feel distinctly missing (or overweighted) then? (And if so, again, how could you correct whatever feels “off” in as simple a way as possible?)

Let’s assume for a moment that you would find those four funds to be sufficient. In that case, the portfolio could be thought of as a short-term bucket with a short-term bond fund, an intermediate-term bucket with a total bond fund, and a long-term bucket with total stock and total international stock funds. Or we could achieve the same thing by looking at it from the overall portfolio allocation perspective (e.g., 15% short-term bond, 25% total bond, 40% total stock, 20% total international stock).

If you find buckets to be helpful, great. But be sure, after creating a bucket-based plan, to step back and look at the whole thing at once.

• How does the overall allocation look? Does it seem reasonable?
• How will it change over time (i.e., will the equity allocation be roughly steady, increasing, or decreasing)? Do you like that?
• Is there a way to achieve the same overall goal with fewer funds?