by Robert Powell
Many advisers, despite the advent of new technology, new products and new thinking, use some fairly old-fashion strategies to create a retirement-income portfolio.
They tend to use the same or slightly modified portfolio they did when devising a saving-for-retirement portfolio, and simply draw down 4% per year. Or they use what's called a bucket approach, the principles of which are based somewhat on the asset-liability matching techniques used by pension plans.
Much has been written about the 4% withdrawal strategy (and its shortcomings), less about the bucket strategy. In my case, the bucket strategy has become the topic du jour for a few reasons.
In 2009, UBS became one of a growing number of large brokerage firms to unveil a bucket strategy. In its version, the first risk bucket contains funds required to fulfill the liquidity needs for an individual over some predefined time horizon.
The second or core bucket contains the bulk of an individual's assets and should reflect the investor's risk preference and be positioned for the maximum return vs. risk.
And the third bucket, the leverage bucket, contains a mix of riskier assets that should be used as a risk overlay and offers the investor the opportunity to dial up or dial down their risk tolerance.
Read about the UBS risk report.
More recently, an adviser built a retirement-income portfolio for a relative using the strategy espoused by Paul Grangaard, CPA, author of "The Grangaard Strategy." That's a strategy in which an investor uses a mix of growth- and income-focused investments and products for many "holding" periods of retirement, and the growth investments/products in the current holding period become the income-focused investment/product in the following holding period.
And another reason had to with an online course about retirement that I just finished teaching at Boston University in which I learned how ingrained the bucket strategy is among advisers. One student said they first began using the bucket approach 20 years ago.
Advisers do indeed use the bucket approach religiously, though each with a slightly different variation. One student, for instance, noted in discussion group how he used what he called a "two-bucket" strategy. Money needed to fund the next two to five years of living expenses is placed in one bucket, in safe, liquid investments not subject to market volatility, such as money market funds and the like. And the remainder is placed in total return portfolio.
Another student, who uses a three-bucket approach, said the following: "I use the bucket, or what some call the time-segmentation approach, religiously. Clients understand it and they open up more when I draw it out. It is an easy concept to grasp and I think it lends credibility."
She also said that prudent diversification to her means spreading risk over many products, using the short-term bucket with bank products; medium-term bucket with a mix of bank and brokerage products; and then the long-term bucket with variable annuities, annuities, bonds, insurance and the like.
Another student used a four-bucket approach. "At our firm we use a time segmentation approach using buckets. Years one to five are for principal preservation; years six to 10 for conservative investments; years 11 to 20 for moderate investments; and years 21 to 30 for growth. This is approach is simple, and has been pretty well received thus far, although it is a constant work in progress."
In some cases, students differentiated buckets not by number but by strategy. One student noted that the main consideration is, what strategy are you employing? Is it a static point-to-point or a waterfall approach? The waterfall is smoother and addresses some of the risks associated with bucketing such as interest rate risk.
All this doesn't mean that advisers don't have concerns about the limitations of bucket strategies. For instance, one student said the weakness with the bucket approach is that it is a continuation of an accumulation or the saving-for-retirement portfolio. And yet another mentioned that creating too many buckets is not without its costs. "I have reviewed many multiple bucket strategies (time-segmented and goal-segmented) and I believe that the ongoing friction of taxes and transaction costs overwhelm the viability of the strategies," that student said.
And another student suggested that bucket strategies don't address the risk of living too long, of outliving your assets. "You still have an issue with tail risk, that is living too long," that student said. "So we would have a conversation about income and legacy and balancing your desires for legacy and the tail risk. If you live to long you are going to spend your legacy. The thought is you have already outlived your primary heirs."
So what to make of all this? Partly this: If you plan on hiring an adviser to build your retirement-income portfolio, you'll likely get some version of the bucket or time-segmentation approach instead of a new-world retirement-income plan, inclusive of, say, income annuities, deferred annuities, longevity insurance, absolute returns funds, and the like.
And the reasons they'll give make sense and are, quite frankly, backed up by research done by GDC Research and Practical Perspectives.
According to that research, there's the cost and expense of some of these new retirement-income solutions and products. There's the issue of whether the benefits of these new products and solutions are superior to that of existing solutions.
There's the issue of track record. Few product and providers have a sufficient history to ensure performance in various market environments. And then there's the issue of complexity. Is the solution overly complex or is it easily understood and transparent?
One student said that although they found the new retirement-income strategy intriguing, without further research they would remain skeptical of the cost and the difficulty of implementing the new-world strategies given the uniqueness and complexity of clients' goals.
In other words, bucket strategies are here to stay for awhile.
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