This morning I woke up at 4 and couldn’t get this idea out of my head. After texting my wife who is visiting her sister in England, I knew I couldn’t fall back to sleep. So, I said, “well, let’s get at it…” And here I am. Sharing with you thoughts that have been kicking around in this old noggin’ of mine.
So, let me start from the beginning. I’ve ALWAYS been a fan of the bucket strategy for retirement. The reason for this is due to the concept of mental accounting. Our brains are wired to compartmentalize things. Thus the prevalence of lists. Ever click on a link “The 5 Best Places to Visit in Maine”? “The 3 Reasons Why You Will Run Out of Money In Retirement”….things like that.
We like things in an organized, easy to follow manner. It eliminates the clutter and makes things easier to deal with.
The bucket strategy is mental accounting. “This is my growth money. This is my income money. And this is my day-to-day money.” Easy to follow and easy to implement.
On a side note, another aspect of mental accounting, and what probably won Richard Thaler the Nobel Prize, is the idea that we are very comfortable spending money from INCOME sources, paycheck, capital gains, dividends… but not so much from principal.
Thus, at least it’s my contention, that one of the reasons retirees spend less isn’t because they are running out of money but rather because of the source of their income. Paychecks are gone, replaced to some degree by Social Security. But the other income a retiree needs has to come from somewhere and it’s from savings. No one likes to spend principal! So, they are more inclined to make due with what they have as opposed to purchasing something they could go without to avoid tapping their principal. It’s a very interesting topic, actually.
ANYWAY, back to the topic at hand. The point of the bucket strategy is two-fold. First, when you separate your immediate income needs into its own stand alone account you do not need to worry about selling a portion of your holdings when the market is getting crushed in order to put food on the table. Markets down 20%? The LAST thing we want to do is sell $10k worth of assets in order to pay for daily living expenses! That’s bad.
So, to avoid that we have that $10k already in reserve from the get-go. People get that concept. Which brings me to the second point of the bucket strategy….people understand it.
Trust me on this, take a retiree and throw him or her into a bunch of products they don’t understand (looking at you annuities and indexed life insurance!) The minute something goes weird in the markets how comfortable do you think those retirees are going to be with their own investments? After the initial sales pitch, they are completely left of their own to figure out what they have.
Think some buyers remorse may set in? Indeed.
Yeah, you could even make an argument with some products that because the retiree didn’t get crushed nearly as much as someone in the market, they’d be more comfortable. Nope. The retiree will say to himself “okay, I’m not getting killed as much as other people, at least I think. I’m not sure why. But I guess that’s a good thing.”
While the end result is seemingly positive, the lack of understanding of how it came to be is not comforting in the least. “What if next time it’s different?” You can hear the retiree’s brain scream in wonder.
Complexity is the enemy of a comfortable retirement. Even if the complexity is ultimately a more efficient and profitable endeavor, the lack of understanding leads to a feeling of helplessness which does NOT create a sound retirement plan.
So, enter the bucket approach. Simple to understand, simple to implement and track. Is it the most efficient way to invest and grow your wealth? No. Not at all. But retirement really isn’t about efficiency. It’s about the ability to sleep at night!
A guy I follow in the industry wrote an article titled “Does The Bucket Approach Destroy Wealth?” His take is 100% correct in that the bucket approach is not the most efficient way to build wealth in retirement. No argument from me there at all. But that point is completely irrelevant. Not one time has anyone looking at retirement, or in retirement, ever approached me and said “you know something Josh, I want the most efficient retirement plan out there in order to maximize my wealth.”
Nope. What retirees worry about first and foremost is running out of money. Solve that and we can talk about efficiency. But is the worry about running out of money ever truly solved? No. Things change, regardless of what one’s software program shows. I did a video on this article here.
The bucket strategy works because people get it. They can actually UNDERSTAND the concept. And with that understanding comes a sense of control and, lo and behold, the ability to sleep at night. This is why I’m such an advocate of it.
I used to advocate a 3 Bucket approach. 2 years cash, 3-5 years bonds, and the rest stocks. Pull money out of cash each year to live on. Replenish that with bond interest and/or stock gains. Wash, rinse, repeat. Easy no?
Well, when I explained the concept in the seminars I used to do, people understood it just enough to NOT ACTUALLY IMPLEMENT IT! It made complete sense to them from a theoretical perspective but implementing it was just a bridge too far.
You could actually see it in the people’s faces when I presented it. They got it… the concept that is. But they weren’t quite sold on it where they could incorporate it for their own situation. Countless people I talked to loved the idea. Then a few months later you’d inquire “hows the bucket strategy working?”
“Oh, I haven’t done it yet. I need to get on that.”
Kind of like when you’d inquire about their estate planning… “Yeah, I know, I know. I need to get that done…”
But you know WHY they hadn’t got it done. It’s a chore! No one likes chores. And thus they find a way to do something, ANYTHING, else.
The thing about the bucket strategy though, unlike estate planning, is it’s not a set it and forget it kind of thing. It must be reviewed every now and again. Yet, if someone thinks it’s a chore just to implement, there is no way on God’s Green Earth, they’ll follow the structure to see it through.
Conceptually makes perfect sense. Taking action??? Well, maybe tomorrow.
And this is why I introduced the 2 bucket approach. Because it’s easier, so much easier actually, to implement and follow. Bucket of cash. Bucket of stocks. That’s it. There are a number of ways to use this approach but generally speaking pull from your cash when the markets are getting knocked around so you don’t have to pull from stocks which are way down. In a couple years when the market has recovered, replenish your cash bucket with distribution from the stock bucket. It’s that simple.
The problem is that bonds are completely absent. No bonds at all. Just cash, which include CDs by the way, and stocks. As easy as it may well be to implement the 2 bucket approach, the problem inherently is the extreme volatility of the 2nd bucket, the stocks.
Remember, the S&P 500 was down nearly 55% from Oct. 2007 to March, 9, 2009. Would the 2 bucket approach have actually alleviated a lot of the concern for a retiree who sees his second bucket down over half?!?!? Probably not.
And then it hit me! Use the Wellington Fund as the second bucket. Wellington consists of roughly 30% bonds and the rest mainly blue chip, US stocks. So, in this one fund, you’re essentially getting buckets 2 AND 3!
Say it costs you $10k to live and you have $100k portfolio. Put 2 years in cash and the rest in Wellington. Of that $80k going to Wellington 28k will be in bonds and 52k will be in stocks. Not a bad portfolio at all. From Oct 2007 through March 9, 2009, Wellington was down 37%. A huge loss, don’t get me wrong. But well short of what happened to the SP 500.
Now, BE ADVISED, I’m not ready to suggest this yet. Wellington has a LONG, and illustrious, track record and as such, I need to do some analyzing. Which is what I plan on doing over the next few days. Just crunching, crunching and crunching numbers some more to see how this shakes out.
And that’s why I woke up so early and couldn’t fall back to sleep. I can’t wait to see how this works. Of course, I’ll do videos on the results and report back to you here. So stay tuned!