15 Comments

1. Right article at the right time, thanks Chris. I started out my early retirement with a smallish cash bucket to hedge out some sequence of returns risk. However, I plan on sticking to the asset allocation approach going forward. As you mentioned in the article, developing strategies to refill the buckets starts to feel like market timing, which is very difficult.

   1. Thanks for the feedback and for sharing your experience dap.

2. Thanks for this article. How does this article relate to “tax” buckets? I ask because I typically think of using buckets when thinking asset location for tax purposes. For instance, how much money to allocate in my tax free, tax deferred, and after tax buckets.

   1. Fres,

      That’s a good question.

      I agree that understanding how much money, both in absolute dollar amounts and as a percent of your portfolio, you have in tax-deferred, tax-free, and taxable accounts is important. Tax location of investments is also worth considering.

      The biggest difference between “tax bucketing” and the bucketing of years of spending when allocating your portfolio that I wrote about in this post is that you have limited control over tax buckets. You may love the idea of Roth accounts or want to defer most of your income in a given year if you are a supersaver, but you are constrained by annual contribution limits to these tax-advantaged accounts. So your allocation to each tax bucket is largely a result of your individual circumstances over the years.

      One area where there is some overlap between these bucketing concepts is that money in a tax-deferred account is not all yours. You owe a portion to Uncle Sam. Money in a Roth account is all yours. In taxable accounts, the basis is all yours. The gain is taxable, but possibly at a rate of 0% depending on your income in a given year. So, it is worth considering how much you will need to pay in taxes in order to bucket out an appropriate amount to cover spending needs you want that bucket to cover.

      Hope that helps.
      Chris

      Best,
      Chris

3. Which buckets to use for spending and when to refill are crucial points. I would love to know the best strategy. You alluded to the long bear market problem and what to do if your safer investments (cash, bonds) are dwindling down. Also, without a bucketing approach there’s a similar question – from which asset class should one withdraw money to fund living expenses? From both proportionally to asset goal? From bonds?

   And finally, what are the tax implications? Is there a difference in taxation whether you withdraw from stocks vs. bonds? What if you keep bonds to maturity, is there a tax difference vs. selling bonds early?

   1. Not-there-yet,

      To your first question about the “best” strategy. That is unknowable for the future. But we can gain some insights from the past. Darrow has published detailed research addressing this blog on that topic.

      Note that in that research, done in 2015 and 2016, the key variable identified to help with this decision, CAPE ratio has not been anywhere near it’s historical average, so how useful this approach is moving forward is unclear.

      Regarding the taxation question, that is more of a factor of which “tax bucket” (see comments above) you are withdrawing money from than whether you are selling stocks or bonds. Any WD from a deferred account is 100% taxable at ordinary income tax rates, WD from taxable accounts are taxable at capital gains rates and so can vary considerable based on the specifics of your situation, and WD from Roth accounts are tax-free.

      Good questions and I hope that helps.

      Chris

4. Great Article Chris! I agree it’s Tomato Tomahto but if it helps get someone’s mind wrapped around it it’s all good
   I am retired and 60/40 but set a mix of Liability matching treasuries and ibonds for the next 4 years to get me to social security.

   never thought about it as a bucket but I guess it is.. a bucket of years…..

   1. Thanks for reading and taking the time to leave feedback Tom.

      All my best,
      Chris

5. Good article and valid if you need 4% per year. For some, the need is lower (even accounting for RMDs) because of fixed income sources, so the resulting bond allocation is less than 40%. This points out the potential inaccuracy of a simple 40% bond allocation strategy, and an advantage of the bucket system. With the buckets, the retiree can actually ‘see’ the year-by-year need as well as the investment set aside to meet that need. All remaining funds can be comfortably invested in stocks to maximize long-term growth. As to refilling, a good portion of the refilling $$ each year can come from earnings on the stock portion which precludes needing to sell in a down market.

   1. Big Red,

      A couple of points.

      -To clarify, your RMD is still part of your total WD that should be accounted for.
      -I agree that an advantage of bucketing is intentionality rather than relying on a generic percentage based asset allocation strategy.
      -Good point on the ability to use earnings on your assets to refill buckets. However, recognize this is not a free lunch. If you reinvest investment income rather than just spending it, you need to sell more shares to meet spending needs. If you just spend the income as it is produced, you can sell less shares. But then you won’t be buying shares of the assets at depressed prices b/c there will be no income to reinvest.
      -All of this points back to an article that I wrote a few weeks ago about a low starting WD rate being the most important thing you can do. It makes all other decisions less risky and complicated. Of course, that comes with its own trade-off. You have to somehow build the portfolio large enough that a small WD can sustain you happily.

      Cheers!
      Chris

6. Good article Chris!

   I highly recommend Cullen Roche’s FAQ and white paper on Defined Duration investing, which takes the somewhat simplistic “bucket” concept and greatly improves upon and refines it:

   https://disciplinefunds.com/defined-duration-faq/

   https://disciplinefunds.com/wp-content/uploads/2023/09/Defined-Duration-Investing-1.pdf

   (There’s a great chart in the white paper that makes the concept clear instantly but of course I can’t upload it here).

   Rather than just setting aside a certain amount of “dry powder” in cash Roche encourages investors to layer in an appropriate range of investments based on how long they typically need to be held. So for example cash (T-bills) is a zero-duration instrument, stocks are on average 17 years, a Total Bond Market fund is ~10 years, and insurance assets like gold or long-term Treasuries are decades-long plays to be used in only small percentages.

   As he discusses in the white paper, classic 60:40 investors got an unfortunate education in the dangers of not implementing duration matching appropriate to their situation last year when their 10 year duration bond funds and 17+ duration equities tanked in unison. They didn’t have anything available to meet their immediate-to-10 year needs and so were forced to sell at a loss if they needed cash.

   Another, simpler way to handle the duration/bucket issue is to do what Jonathan Clements does (also recommended by William Bernstein and DFA): use short-duration (1-3 year) Treasury funds or ETFs exclusively for your fixed income position (with a modest cash emergency fund in T-bills or a Treasury money market account of course and, as the saying goes, “take your risk of the equity side.” I do exactly what Clements does: half in VGSH and half in VTIP so I’m agnostic about inflation but am keeping the duration short enough that I have oodles of access to “cash” in a market crash. Of course you’re giving up the chance of benefitting from a flight-to-safety event but like Dr. Bernstein I think the advantages greatly outweigh that infrequent and by no means guaranteed scenario (people forget that equities and bonds crash together quite often; it’s like they forget there was market history before the 2008 GFC).

   Thanks as always for your writing!

   1. Kevin,

      Thank you as always for your thoughtful comments and for sharing those resources.

      As I continue to read and learn, I continue to take a similar approach with my own portfolio and with clients I advise regarding the idea of using cash/short-duration treasury funds for 3 years of expenses. However, even if that will get you through most bear markets, I think for most retirees (and even me with some ongoing earned income and the ability to ramp it up if needed), the level of volatility risk that comes with that approach would make it tough to sleep at night and possibly bail at the worst possible time.

      So, I personally continue to fill in the gap between the cash “buckets” and stocks with a few more years of expenses allocated to a total bond fund and/or intermediate term TIPS (and I’m still holding on to a little gold…. for now 🙂 ).

      Best,
      Chris

7. Bucketing and asset allocation appear the same with the $1M example, but not at higher balances. For example, if Sally started with a $5M nest egg with the same $400K in the cash/bond bucket, it would only be 8% of her portfolio, not 40%. If that covers 9 years of her spending needs, she may not want $2M (40%) in cash/bonds. Also, if equities dropped significantly, Sally may not want to rebalance from her cash/bonds, as this would reduce her 9 year cash/bond goal. Steven, on the other hand, would rebalance in support of his ratio goal. Subtle differences, but they are slightly different approaches. One is primarily focused on ensuring the cash/bond bucket is sufficiently funded for a target duration whereas the other is primarily focused on a target ratio.

   1. Tom,

      Good points. Thanks for chiming in.

      Best,
      Chris

8. 5 years into retirement, my overall AA is roughly 60/40 spread across R-IRA, SD-R-IRA, HSA,T-IRA, taxable brokerage, B&M bank and I-bond accounts at TD. The mental buckets that resonate with me are “Spend now, Spend later, Spend never” or “Cash, Income and Growth”
   “Income” is 50/50 equities and bond funds with interest, cap-gains and dividends spent not reinvested.
   “Growth” is 100% equities with everything reinvested.
   There is no rebalancing because its too hard for me and no selling of shares because the income is sufficient. I’ve been including the income in the 2-3% WD rate but read somewhere that “organically generated” income doesn’t need to be included.
   That would make my WD zero but that cant be right can it?
   Good Article.
   Thanks!
   -JT-

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