Discussing Retirement Bucket Strategies with Fritz Gilbert – SWR Series Part 55

January 25, 2023

Welcome to another part of my Safe Withdrawal Rate Series. Today’s topic: Bucket Strategies in retirement. As you know, my blogging buddy Fritz Gilbert has written extensively on this topic at his Retirement Manifesto blog, for example:

And likewise, I have written about my skepticism of bucket strategies in Part 48 of the series: “Retirement Bucket Strategies: Cheap Gimmick or the Solution to Sequence Risk?

Fritz’s most recent post on the Bucket Strategy started a lively back-and-forth on Twitter, and it seemed appropriate to pursue a more detailed discussion with more than 280 characters per answer in a “fight of the titans” blog post. So if you haven’t done so already, please check out our awesome discussion over on Fritz’s blog:

Is The Bucket Strategy A Cheap Gimmick?

The response was overwhelmingly positive, and we decided to craft a follow-up post here on my blog. We came up with two new questions, and we also need to address two major themes from the comments section in Part 1, specifically, the role of simplicity and behavioral biases in retirement planning.

So, let’s take a look…

Before we get started, though…

I just wanted to announce that I will be a speaker/presenter at the Fall 2023 Chautauqua meeting in Ecuador. If you’re unfamiliar with the event, the FIRE Chautauquas started in 2013 in Ecuador, just north of Quito, at the “Above The Clouds” Hacienda in a beautiful, relaxed subtropical environment. The local organizer is Cheryl Reed. Previous speakers include Mr. Money Mustache, Paula Pant (Afford Anything), and many more thought leaders from our small but growing community.

And – you can’t make this up – Fritz Gilbert and Justin from the awesome Root of Good blog will be the other speakers. So, Fritz and I can continue our Bucket Strategy discussion there, and I’m sure Justin wants to weigh in as well. Registration is now open, and attendance is limited to only about 16-20 guests, so please make sure you book before the spaces are sold out.

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Also, notice that this year there are two weeks of Chautauqua. The first event is in July/August with an equally amazing guest list: Tanja Hester (Our Next Life), Bitches get Riches, J.D. Roth (Get Rich Slowly), and the Fioneers. I will only attend the second event from September 30 to October 7. You can register on the Above The Clouds website and find more information there, too.

And now, back to the Bucket Strategy discussion…

1: How important is simplicity in retirement planning?

Fritz: 

Let’s start with “how important is retirement planning?”, to which I’m sure we’ll all agree the answer is “Very.”  The transition from the Accumulation Phase to the Withdrawal Phase is, perhaps, the largest transition you’ll make in your financial life, and it’s far too complex to jump into it without a plan.  (See “Our Retirement Investment Drawdown Strategy” for our master plan, with links to 23 other bloggers’ drawdown strategies, including Big ERN’s as the #10 link). 

That said, retirement planning is complex.  What should your Safe Withdrawal Rate be?  What should you target for your Asset Allocation? Should you do Roth conversions?  Which accounts should you draw from first? How do you cover health insurance?  Etc. etc. etc.

Therefore, any simplification that can be done brings significant value.  My goal has always been to simplify wherever possible without losing the critical elements of the plan.  Finding ways to simplify the implementation of a strategy increases the likelihood that the strategy will be followed.  A sound strategy, implemented poorly, equates to a poor strategy.  Secondly, the ability to explain a complex strategy in simplified language can be extremely helpful when communicating your plan to the ones you love.  Typically, most marriages include one partner who loves the financial detail and one who doesn’t want to be bothered with the details.  Being able to simply communicate your plan increases the odds of alignment with the strategy.

Bottom Line:  Simplification matters, primarily in the fact that it increases the probability that the strategy will be properly implemented when it matters the most.

Karsten: 

One issue that came up in the comments section in Part 1 is that readers prefer the method that’s simpler to manage. I certainly have sympathy for that. If we assume for now that both methods are about equally useful but also equally susceptible to Sequence Risk, then who wouldn’t want to pick the simpler of the two? Intriguingly, most commenters on Fritz’s blog preferred the Bucket approach. Like this one:

I was puzzled because I was under the impression that a simple Strategic Asset Allocation (SAA) seems to have far fewer moving parts than a bucket strategy, where you must constantly decide what bucket flows where and when to replenish and rebalance the cash bucket; effectively a form of market timing that is anything but simple. So, SAA is the equivalent of “remove old bulb, install new bulb” when the bucket strategy needlessly complicates the whole process.

Then how can readers claim that my method is too complicated even though it’s objectively much simpler than a Bucket Strategy? I came up with an analogy. Imagine there are two teams of portfolio managers, one working for an actively managed fund and one running the VTSAX at Vanguard, a passively managed total US stock market index fund. The active managers claim that they can outperform the index fund. The index fund managers take on that challenge and provide many pages of research results showing how active managers have trouble consistently beating an index fund. And they thought that would settle the argument, right? Boy, were they wrong because you know what happened? Readers of this exchange now say that they prefer the simplicity of the active managers because index fund investing seems way too complicated. And the index fund managers wonder what the heck just happened here! That’s how I felt after reading the comment from “Jeff in MN.” When comparing the two approaches, people got sidetracked by the necessary quantitative and analytical considerations. But the average retiree should focus on what method is simpler in practice. You don’t have to replicate the analytical work on my blog to run a simple SAA strategy. I do the work here, so you don’t have to! It’s like driving a car; you don’t have to understand all the mechanical and engineering details. The mechanics and engineers did that for you, so you can enjoy the simplicity of driving your car.

So, in a nutshell, the initial step, figuring out the target asset allocation, is the same for both methods. But the simple SAA approach requires no additional tactical asset allocation and market timing; therefore, it is simpler to implement than the Bucket Strategy. It’s another reason I prefer my approach.

A casual reader might wonder now whether my philosophy has changed. Isn’t Big ERN supposed to be the math wizard who overthinks and overcomplicates everything? Not at all. I want simplicity when that’s all we need. If you recall my 2021 post “When to Worry, When to Wing It,” I go through a laundry list of possible complications to my simulation setup. Some of them we can safely ignore because, in the grand scheme, they make very little difference in historical simulations.

As Fritz states above, very correctly, some financial planning challenges are more complex in retirement than in the accumulation phase. I have spent years researching safe withdrawal rates. The asset allocation in retirement, especially the tactical deviations from the SAA, would be one part of retirement planning that we can and should keep simple. Focus instead on the withdrawal rate and how we need to adjust it in response to idiosyncratic parameters and market valuations.

2: How should retirement planning address behavioral biases?

Karsten: 

Another common thread in the comments section on Fritz’s blog was the issue of behavioral biases in personal finance. I’m the first to admit that most people, myself included, are inflicted with behavioral biases that often draw us away from making optimal financial decisions.

Several commenters pointed out that the presence of such behavioral biases justifies applying the bucket strategy to get jittery retirees over their fear of withdrawing money in retirement. I was intrigued that two of the proponents of the bucket strategy are financial planners (see the comments from “Liz” and “Eric“).

The bucket strategy falls into the behavioral bias called “mental accounting.” I wrote a post in 2016 about the topic, and back then, I defined this bias as follows:

Mental Accounting: Intentionally or unintentionally creating different buckets of money and ignoring the fact that money is fungible; displaying different degrees of risk aversion and/or different propensities to consume out of different buckets.

It’s almost like I knew in 2016 that I would have this discussion with Fritz in 2023! In any case, my response to folks who justify the bucket strategy to address behavioral biases is that if you’re a financial planner, it’s your job to explain to your clients what you’re doing. Why resort to crutches like the bucket strategy, then? The truth is liberating, so please repeat after me…

A balanced stock/bond portfolio, regularly rebalanced, would have withstood all the past market volatility, including the Great Depression of the 1930s and the Great Inflation of the 1970s/80s, and will likely survive whatever the future will bring.

There you go; with those 37 words, you can explain to the client that the simple SAA is really all you need. Maybe add a few charts and tables to enforce the massage.

In fact, if I were malicious, I would believe that the reason for the popularity of the bucket approach among financial planners is slightly sinister. Is it possible that the industry needs a selling point for its services to distinguish itself from DIY investors? Is it possible that CFPs falsely insinuate that they can do the tactical asset allocation timing better than the average Joe investor with an SAA approach? I would find it much more ethical if the industry tried to educate people about the dangers of mental accounting instead of reinforcing this potentially dangerous behavioral bias.

The discussion reminds me of my old post, “Good Advice vs. Feel-Good Advice.” Sometimes financial planners and financial celebrities on TV or the internet market feel-good advice that may not be as good as it sounds and feels. Granted, at least the bucket approach is just hit-or-miss with zero average impact, while some of the behavioral biases highlighted in my old post are certifiably stupid and mathematically inferior. So, I’m not going to lambast the DIY investors using a bucket approach if they feel that’s the right thing to do. Fritz and his fans are totally on the safe side. But it’s my job as an educator of sorts to point out that a simple SAA works just as well, on average. Apparently, I’m doing a job that the average financial planner can’t or doesn’t want to offer.

Fritz: 

All of us will face a bear market during our retirement years, most likely several. It’s just the nature of the beast (pun intended).  Having a pre-determined plan for how you’ll handle the emotional response to “losing” 20% of your net worth when you’re dependent on those assets to fund your retirement lifestyle is critical. It must be addressed in your retirement plan.  The worst thing a retiree can do is liquidate stocks after a major downturn due to panic, which turns Sequence of Return Risk from a concept into a reality.  

By highlighting the importance of maintaining short-term liquidity to fund your next three years of retirement spending, The Bucket Strategy forces the retiree to think about the reason “Why,” and highlights the genuine prospect of having to live several years without selling stocks during a downturn.  By forcing a decision on the size of Bucket 1 (1 year?  3 years? 5 years?), the strategy requires a retiree to consider their risk tolerance and pre-determine their defense against an inevitable bear market and the resulting SORR.  

Further, many retirees fail to rebalance and, in a Bull Market, could see their risk exposure unintentionally increase beyond their preferred tolerance.  Getting caught up in the euphoria of a Bull Market is another behavioral bias that must be addressed with an effective plan.  Again, the Bucket Strategy, with its emphasis on systematic “refilling” of Bucket 1 based on Asset Allocation movement, provides some protection by automating a “Sell The Winners” approach. It’s also important to note that these rebalancing moves are not driven by market timing, but by a systemic review of asset allocation during the quarterly refill process.

Importantly, The Bucket Strategy also provides a simple means to explain to a spouse what you’re doing with your investment portfolio given the current market dynamics, and why you’re doing it.  It’s not only the behavioral bias of the one managing the investments that matters but also the biases of other people in the relationship who may have anxiety when they see the news headlines and worry if they’ll run out of money. In my case, my wife takes comfort in understanding the broader strategy and my simplified explanation of actions we’re taking in our portfolio.  I’ve heard the same from many of my readers.

Another behavioral factor is the reality that many retirees struggle with giving themselves the freedom to spend in retirement.  After a lifetime of diligently saving, it is a difficult adjustment to change one’s habit and learn to spend in retirement (within your SWR limits).  By establishing an “automated paycheck,” many find it comforting to know they can spend whatever is flowing into their checking account.  In the event of under-spending the checking account balance grows, which is a helpful reminder that the retiree is “safe” in increasing their spending to consume the surplus (or, perhaps, to donate it to a cause they believe in).  Also, the annual review process allows a simple methodology to implement flexible spending rules in conjunction with the bucket strategy, which has been proven the most effective means to ensure you don’t outlive your money.

The Bucket Strategy provides a simple solution that protects against many of the common behavioral biases using an easy-to-understand methodology.

3: How Do You Effectively Manage The Bucket Strategy?

Fritz:  

I’ve written two posts on how I manage The Bucket Strategy, one written in a Bull market and one in a Bear Market.  I’ll summarize the key elements of managing the buckets below but would encourage you to read those posts for more details. 

First, it’s important to touch on the starting point, as discussed in Post 1 of this discussion with Big ERN and in the first post of The Bucket Strategy Series on my site. The starting point dictates the Asset Allocation, as determined by the size of each bucket.  From Post 1:

For the sake of an example, let’s assume you hold 3 years of cash (Bucket 1), 6 years of bonds (Bucket 2), and everything else in stocks (Bucket 3).   If your portfolio equals 30 years of spending, the asset allocation becomes:

  • Cash: 3 Years (10%)
  • Bonds: 6 Years (20%)
  • Stocks: 21 Years (70%)
  • Total: 30 Years (100%)

I maintain Bucket 1 cash in a stand-alone CapitalOne360 money market account and set up an automated ACH transfer every month (my “Retirement Paycheck”).  By simply comparing my balance over time, I can quickly determine my spending level.  For example, I can subtract the 3/31/22 balance from the starting position on 1/1/22 to determine my retirement spending in Q1 22.  As part of my refill process, I also check my current Asset Allocation using Personal Capital and incorporate rebalancing considerations into my refill decision.

In a Bull Market, I will refill the amount of spending each quarter, selecting either stocks or bonds based on which has outperformed in the quarter (using Asset Allocation as the guide). For the sake of simplicity, I’ll provide examples assuming refills are conducted only on 12/31 of each year.  Here is an example of how I would refill in a Bull Market:

In this example, you can see Bucket 1 has been refilled to 3 years of spending (+$40K), but the cash allocation declines to 9% given the overall portfolio’s growth from 30 years to 33.5 years of spending. Stocks have been rebalanced from 75.2% to 70% ($70k rebalanced, with $30k to bonds and $40k to cash), and bonds have been increased from 18.8% to 21.0%.  

In essence, maintaining Bucket 1 at the 3 years of spending in a Bull Market results in a reverse glide path approach, with the cash bucket falling as a % of the AA and the bond/equity portion increasing over time.  Assuming the growth of the portfolio exceeds the rate of inflation, this phenomenon would also be exhibited if spending increases at the rate of inflation, though at a slower rate than shown in the example above.

In a Bear Market, I will review my portfolio to see if there are any holdings that have had a positive return from the date of the last refill.  I compare Asset Allocation vs. target, but allow actual allocation %’s to float in a range with a “floor/ceiling” approach. Depending on the results, I’m content to skip the quarterly refill and draw down the cash in Bucket 1.  This avoids selling positions in a bear market and provides some protection against SORR.  The following is an example. 

In this case, since both stocks and bonds have declined but remain near the targeted AA %’s, Bucket 1 is not refilled and cash is drawn down from 10% to 8.4%.  The entire portfolio has declined from 30 years to 23.9 years of spending, but no stocks or bonds have been sold to fund retirement spending (providing some SORR protection).

To complete the example, following is what Year 3 would look like assuming a market recovery (Stocks up 15%, Bonds up 5%).  For comparison, I’ve included in the right-hand columns an example using a strict SAA approach (assumes the same starting point, but maintaining 70/20/10 allocation throughout, as I believe Karsten would recommend)

By comparing the two approaches, you can see The Bucket Strategy actually results in a slightly higher balance over the three-year period ($1,027,000 vs. $1,025,940), given that no stocks or bonds were sold during the downturn with The Bucket Strategy approach.

In reality, there is very little difference between the two approaches. In my mind, it simply comes down to the preference of the retiree and which concept is more easily understood in their mind, along with the comfort of knowing you can target whatever size cash bucket best suits your risk tolerance.  I find it easy to explain the bucket concept to my wife (as do my readers, based on comments received), and that’s a yardstick that matters to me.  In essence, The Bucket Strategy is simply a modified SAA approach, with an increased focus on the management of the cash balance in Bucket 1.

On a side note:  starting in mid-2022, I also redirected any interest/dividend payments to be automatically transferred into cash (instead of automatically reinvesting) in my After-Tax accounts, which reduces the amount of selling required to refill the bucket at quarter-end.  I continue to automatically reinvest dividends in my Roth and IRA’s.

Karsten:

I don’t use a bucket strategy, so I have little to manage. In fact, I firmly believe that you can’t effectively manage a mostly ineffective strategy. Thus, I like to take the opportunity to rephrase the question into this:

“Why is the Bucket Strategy Mostly Ineffective?”

The answer to that question is that in historical safe withdrawal simulations, a bucket strategy would not systematically hedge against Sequence Risk. For some historical cohorts, a bucket strategy indeed outperforms a simple fixed weights SAA. But in other cohorts, a bucket strategy would lag the SAA. Thus, the bucket strategy can potentially even exacerbate Sequence Risk.

I also found that the bucket strategy’s relative performance is often susceptible to small parameter settings changes. Also noteworthy, a glidepath systematically outperforms both the SAA and the bucket strategy.

Showing all my detailed simulations would go beyond the scope of this Fritz vs. ERN discussion because it would involve a lot of charts and a minimum of 3,000 words on its own. Watch out for a detailed future post in this SWR Series. So, in today’s post, let me give you the 30,000-foot view. Let me outline the intuition for why the bucket strategy would have had such inconsistent performance in simulations. 

Here’s a numerical example that’s rich enough to convey the intuition but simple enough to handle and not lose the forest for the trees:

  • The initial portfolio value is $1,000,000
  • Annual withdrawals are $40,000.
  • There are two assets, one risky (e.g., stocks) and one safe (e.g., bonds/cash).
  • The target weights are 70%/30% for the risky and safe assets.
  • We take the first withdrawal proportionately at the end of year 0, i.e., $28,000 from the risky and $12,000 from the safe asset.
  • In subsequent years, we start withdrawing from the asset bucket that’s above its target weight. If drawing the entire annual budget from that asset still leaves the asset weights away from their targets, there is no further rebalancing. Specifically, suppose the risky asset goes into a deep enough bear market. In that case, we’d withdraw the entire $40,000 annual budget from the safe bucket and let the risky asset weight slip below the 70% target to avoid withdrawing at the bottom of the bear market.

And that’s it. There are no other bells and whistles like shuffling around dividends or interest payments. That is all just a gimmick, anyway. And in the worst case, it may even hurt the investor – more on that in a future post.

In any case, there’s your Bucket Strategy. And we can now check if and how this approach would help us during a bear market and the subsequent recovery.

Let’s assume that the safe asset gives us a 3% return every year, and the risky investment goes through a 3-year bear market and 5-year recovery, as in the numerical example below. If you think the bucket strategy would perfectly hedge against this Sequence Risk, you’d be very much mistaken. Quite the opposite, after eight years, the bucket strategy lags the SAA fixed weight asset allocation by over $3,000. Not a significant difference, but considering that a bucket strategy is often misleadingly marketed as the panacea against Sequence Risk, even a “SoRR Insurance,” this is very disappointing. Let’s see in detail why the Bucket Strategy performs so poorly:

  • First, notice that after the mild drop in the risky asset in year 1, the portfolio is still rebalanced back to the 70% weight simply by withdrawing about $28k from the safe bucket and about $12k from the risky asset. Bucket Strategy proponents, Fritz included, to my knowledge, often stress that small enough equity fluctuations should not yet trigger the bucket strategy, so I replicate this feature here.
  • However, after a second and more significant 15% drop in year two, even withdrawing the entire annual budget from the safe bucket and leaving the risky asset bucket untouched, we are left with only 69.2% in the risky bucket at the end of the year after the withdrawal. But notice that, so far, the bucket strategy hasn’t added any value: both portfolios, SAA and Bucket Strategy, end year two with the same value of $769,116.
  • The lower equity weight at the end of year two will help you when the risky asset further unravels in year 3. After the drop of 25% and the withdrawal coming entirely out of the safe bucket again, the bucket strategy is $1,633 ahead of the SAA. The risky bucket now stands at 66.2% at the end of year three.
  • That underweight in the risky asset now hurts us in year four because we miss out on the stark reversal in returns (+40%). The bucket strategy is now over $6,000 behind the SAA model. Now withdrawals will come entirely out of the equity bucket because the cash bucket is well below its 30% target.
  • For the remainder of the simulation, even after withdrawing the entire $40k from the risky asset, the risky weight stays above 70%. Now we can milk this positive momentum in the risky investment and gradually recover some of the prior losses. But even at the end of the simulation, the Bucket Strategy is still more than $3,000 behind the simple SAA.

The outperformance of the Bucket strategy relative to SAA is all tied to how future returns correlate with your current asset weight deviations from the fixed 70/30 SAA. And your current tactical asset weight correlates with past asset returns. Does that sound familiar? The bucket strategy functions like a momentum strategy. As I outlined above, that’s a form of TAA. And TAA based on such a naïve, crude, and purely backward-looking rule, i.e., scaling back the risky asset weight after an extended drawdown, is always hit-or-miss.

Sometimes you get it right, and the stock market continues to fall, so the momentum strategy pays off. But if the market recovers quickly, like after the Great Depression bottom in 1932, the 1987 meltdown, or the GFC bottom in March 2009, you got caught on the wrong foot; the Bucket Strategy vastly underperforms during the recovery period.

It’s nice to see that the intuition and mechanics of this simple numerical thought experiment are also present in my more complicated simulations with three assets (stocks, bonds, money market) and all the other bells and whistles, like monthly vs. quarterly. vs. annual withdrawals, occasional rebalancing, “buying the dip,” upper and lower bands on the asset weights, transfers of dividends and interest income, etc. (stay tuned for a future post on my blog). All those other ingredients are just clutter and distract from the essential mechanism of the Bucket Strategy: asset return momentum. Sometimes it works, and sometimes, it backfires. It’s the main reason why the Bucket Strategy cannot consistently beat the simple SAA assumption of fixed asset weights.

And I want to stress when I say that the Bucket Strategy is ineffective, I don’t mean that it is so bad that you shall never employ it. I could have reshuffled some of the annual returns to construct an example where the BS outperforms SAA by $1,000, like in Fritz’s example above. The bucket approach is unable to beat the SAA reliably and consistently. You can still use it, but don’t expect miraculous results in hedging against Sequence Risk. And absolutely don’t expect the Bucket Strategy to offer full SoRR Insurance.

The entire discussion reminds me of the misleadingly labeled “Yield Shield.” Raise your dividend yield to about 4%, and you now have a perfect “shield” against Sequence Risk. Only you don’t. It’s a hit-or-miss strategy, too. Sometimes you do better than a plain old index fund strategy. Sometimes you do worse, most recently during the Global Financial Crisis and in 2020. I pointed out that issue in Parts 29, 30, and 31 of my series. I’m not saying that you consistently underperform the passive index fund approach with either the Yield Shield or the Bucket Strategy. But you cannot consistently beat the passive approach with such gimmicks, either. And even in the cases when momentum works in your favor, the impact on your portfolio is so minor (e.g. just $1,000 in Fritz’s example) that you can’t really claim victory over Sequence Risk. This goes back to the point I made in Part 1 about how the sizing of the TAA bets is insufficient to make a difference in your safe withdrawal rate, even if you generate a little bit of TAA momentum alpha.

Also, just like the Yield Shield proponents, Fritz declares that his strategy is “working.” But Fritz is vague about what he means by “working.” If “working” means he hasn’t run out of money yet, that’s a very low bar. That’s not what our discussion was about. We need to set the bar much higher: the comparison should be, is the bucket strategy better than a simple SAA approach? Fritz didn’t provide any simulations to present how he would have personally fared with the much simpler SAA approach since 2018. And granted, I presented only one numerical example and had to defer the detailed simulations to a later post.

But if you are a regular reader of my blog, you will remember Part 39 of my SWR Series; I performed very detailed simulations to study a related issue: how changing the rebalancing frequency would have changed the experience of historical retirement cohorts. It’s the same hit-or-miss experience: sometimes, the asset weight drift helps you when you can milk that asset return momentum. Sometimes the drift hurts you when asset returns go through extreme whipsaws. This lack of reliable alpha relative to SAA is true in “made-up” numerical examples and historical cohorts. And I will show in a future post that the same holds for the bucket strategy.

4: If The Bucket Strategy is a gimmick, what’s the better strategy, and how do you manage it?

Karsten:

The way to manage Sequence Risk is to a) acknowledge that it exists and b) understand when Sequence Risk is more likely and less likely. If you retire while equities have been in a long bull market, you likely want to start with a lower initial safe withdrawal rate. But on the flip side, if equities have already fallen by enough, for example, in 2022, we can also afford to raise that safe withdrawal rate; see my recent post in the SWR Series on this topic.

But of course, there is relatively little we can do to insure against Sequence Risk fully. The best we can hope for is to hedge against Sequence Risk partially. The one method I’ve mentioned in our exchange that appears to be consistently beneficial during all past bear markets is the glidepath model. And indeed, I have marginally raised my risky asset share over the last four years. Post-retirement, I now have two bear markets under my belt. Knock on wood; those downturns were mild enough not to threaten my finances. Quite the opposite, our portfolio is up significantly despite the market volatility. We can now afford to take slightly more risk. But to new retirees, I still recommend using caution right around the retirement date. Start with a somewhat larger safe asset bucket and ease yourself back into risky assets as time progresses.

Another route to enhance retirement success is to think outside the box, i.e., employ asset classes outside the spectrum of assets in your standard retirement calculators. Real estate would be one option. But it’s not for everyone. I certainly don’t want the hassle of managing the day-to-day operations of a rental property portfolio. So, we have shifted about 12% of our investments into private equity real estate funds. If interested, please get in touch with Reliant Capital – accredited investors only, $250k minimum investment. We have less control over the investments, but we also don’t have to waste time dealing with tenants and plumbing problems on Christmas Eve. I also like the broad diversification over different regions and multiple properties. Moreover, these large multi-family properties offer enough diversification over idiosyncratic tenant risk. So far, we are happy with our investments and will likely shift more of our portfolio into this asset class.

Another approach involves an “alpha strategy” with a better prospect for adding excess returns than an unreliable TAA momentum approach. I have been running an options trading strategy with a neat track record. The strategy involves selling put options on the S&P 500 index. You trade derivatives on margin; thus, my strategy doesn’t require me to shift any of my existing assets; rather, I trade the options strategy on top of my current portfolio. The idea is to enhance the returns of my existing 75/25 portfolio and add about 1.5-2.0% additional returns with only small correlations to my existing asset classes; see the efficient frontier diagram below. The details of the strategy would go beyond the scope of today’s post, but here’s a link to my most recent write-up about this strategy.

You cannot shift the efficient frontier that far with a hit-or-miss TAA strategy based on backward-looking momentum signals and applied to just 10% or so of your portfolio. But that said, I don’t recommend any options trading strategy unless you have extensive knowledge in derivatives trading and risk management. It’s probably a bridge too far for most folks in the FIRE community. But I plan to offer this “short-put yield” strategy to a small number of high-net-worth clients at a future date, so stay tuned!

Fritz:

I like and support the concept of the Glidepath model and believe it’s actually a concept that supports The Bucket Strategy being a sound strategy.  As I mentioned, it’s my belief that The Bucket Strategy naturally leads to a Glidepath model, assuming the growth of the portfolio exceeds the SWR over time.  If one keeps Bucket 1 at a maximum of 3 years and the market outperforms the SWR (as it should over time), the retiree’s risk allocation will, by definition, increase.  In fact, the only time the Bucket Strategy would not lead to increased exposure to risk assets is if the market were underperforming, which is the time you would be pleased to not have the additional risk exposure.

It seems to me that The Bucket Strategy is perfectly aligned with the Glidepath strategy, given that it will lead to an increase in risk assets (assuming a rate of return > withdrawal rate).  In a longer-term timeframe in which growth exceeds the SWR, a retiree using The Bucket Strategy would see an increasing risk exposure with time, which is exactly what the Glidepath model dictates.  

An interesting side note:  This phenomenon could lead to drastic changes after the retiree begins drawing Social Security, assuming the buckets were “sized” based on pre-SS figures.  Using the asset allocation example from earlier, and assuming the same portfolio size, let’s assume a retiree now has Social Security income that covers 50% of their spending (and their spending stays the same).  By definition, this would lead to a 50% reduction in the annual portfolio withdrawals.   Theoretically, there could be a huge increase in equity exposure as the portfolio grows from 30 years of spending to 60 years of spending (a simplified example to make a point):

  • Cash:  3 Years (5%)
  • Bonds: 6 Years (10%)
  • Stocks: 51 Years (85%)
  • Total: 60 Years (100%)

I realize that’s an extreme example (to make a point) and many are already using Social Security and their portfolio to cover their spending.  If they’re already drawing SS and using a SWR of 3.3% (1 year of spending from a 30-year portfolio) to cover their spending, they obviously wouldn’t see the impact shown above.  Rather, I point it out for those retirees who have calculated their Bucket Strategy on their pre-SS scenario and haven’t thought about how the introduction of SS changes the numbers.

The Bottom Line:  The Bucket Strategy is not a cheap gimmick.  It’s a sound strategy, with some defense against SORR, elements of the often-referenced Glidepath strategy, and ease of execution for DIY retirees.  The strategy allows a retiree to cover their retirement spending with a minimal amount of management and stress and will allow them to sleep soundly through all but the worst of the inevitable bear markets we’ll face through our retirement years.

PS – Finally, I should stress that my goal with The Bucket Strategy is not to “achieve Alpha.”  Rather, it’s to have a strategy that allows me to sleep well, enjoy living in my retirement years, and know in advance what changes should be made to my portfolio based on market performance. To me, the Bucket Strategy achieves that goal, and knowing it should also lead to a Glidepath allocation (which has been proven by Big ERN to be the most effective model) gives me the assurance that the returns will be sufficient to support my lifetime spending needs.

5: Final final thoughts?

Karsten and Fritz: 

We hope you enjoyed our exchange. This wasn’t exactly the “celebrity deathmatch” that some readers expected or feared. We really agree on most issues. We are good buddies, and we respect each other’s work. We also frequently refer to and link to each other’s blogs. One of the commenters in Part 1 put it best; see below. Well, ThomH, your comment is a worthy final word that made us warm and fuzzy, too. And we hope to see you and your wife in Ecuador!

Thanks for stopping by today! Please leave your comments and suggestions below! Also, make sure you check out the other parts of the series; see here for a guide to the different parts so far!

Picture credit: pixabay.com

51 thoughts on “Discussing Retirement Bucket Strategies with Fritz Gilbert – SWR Series Part 55

  1. “And the index fund managers wonder what the heck just happened here!” I totally get your reaction on this one but it’s totally your fault Karsten, with your overly complicated math and excessive analysis. Something that should be simple becomes a monster. Just go back to your SWR series, would someone find that simple? You’d need a math PhD to understand half of that…so I’m sorry but you have a great deal of fault on this one.

    1. I completely disagree with this comment. The SAA approach could hardly be more simple. The most difficult aspect (applicable to either strategy) is selecting how much of one’s portfolio is to be allocated to risk assets. After many months of dithering, I’ve settled on 70%. I now carry out a rebalancing once a year and that’s pretty much all that’s required!

    2. Not sure if this is a troll/sarcasm comment. But you comment is a slightly less civil version and a lot less thoughtful version of the ‘Jeff in MN” comment.
      Math Ph.D. material reads like “theorem, proof, theorem, proof, lemma, proof,…”
      On my entire blog, I’ve never published anything even remotely similar to Math Ph.D. level. This is all just basic applied math and personal finance.

      1. I’m sorry, I must be an idiot then because I find your analysis and calculations extremely difficult to understand. But again, I work in construction and I don’t have a college degree which seems to be a prerequisite to become FIRE. I’m sorry

        1. OK, understand.
          I don’t need to understand every step you are taking when doing your work. But I’m happy there are people that specialize in construction.
          And I appreciate the work my buddy Gary is doing when he helps me with construction projects around our house.

          I also hope that folks without a college degree can benefit from the insights in the FIRE movement. The formula is the same (save, invest in index funds, rinse and repeat and watch your portfolio grow), but I concede that it may take longer if your income is lower.

      2. Karsten, Many of us appreciate that the points you make are backed up by worst case analysis based on math and history, instead of just hand waving with one example. Many times while reading your articles, I think of some worse case scenarios, “what if…”, and your next point addresses exactly that, with details to demonstrate the answer. So your articles are well thought out, with simple points for those who are not interested in the math, and also the details for those of us who find it difficult to bet our retirement on someone else’s hand waving.

    3. I disagree. Even though I don’t fully understand the math behind (I’m a chemist) I feel that seeing all that goes behind Karsten’s results gives me full confidence in his conclusions. That’s the only blog to my knowledge that goes so deep in the analysis and that’s why I will follow his strategy.
      Thanks for the excellent work Karsten. Hope you can give us your opinion on the state of the economy. Also for your international readers like me, if you could sometimes make simulation with world index instead of S&P500 it would be very appreciated 🙂

      1. Thanks Sebastien! That’s a sentiment I hear a lot: the math helps people get over their fear of early retirement. It helps us quantitative/logical/scientific people in a way that some of the psychological mumbo-jumbo just can’t.
        I’m glad I’m not the only one thinking that way! 🙂

  2. “there is relatively little we can do to insure against Sequence Risk fully. The best we can hope for is to hedge against Sequence Risk partially ”
    This is not reassuring at all ! It scares me to a point that I prefer to keep working than having to face this.

    1. Uuhhhm, that’s not my intention. I initially thought that there is no safe withdrawal rate for retirement lengths 50+ or even 60+ years. Turns out, with a SWR slightly less than 4% you can safely retire. Even with the the sequence risk.

  3. Thanks for both your work. What you do is important to many who, due to limited financial experience (like the commenter above), rely on financial advisers blindly. This should give them comfort – whether they understand or not.

    Switching gears here, do you have any resources that compare the “37 words” assumptions you make for the last century (2B pop in 1900 to 8B today) to a century with zero population growth? What should long term stock multiples be with zero secular growth at various rates of inflation?

    1. Thanks!
      Great question. There is some concern that demographic change (slower population growth, more old people vs. young) will have an impact on asset returns. I doubt that this effect is that large for stocks. Demographic change is slow enough so that the capital stock will also grow at a slower rate. And mean expected rates of return will not fall off a cliff as some people predict.
      But there is a concern that larger debt burdens and more government involvement will lessen our productivity.
      But there’s also the hope that some technological advancements like AI, Machine learning, etc. will boost productivity and make up for the losses.
      So, overall, I think it’s not a crazy assumption to use the same return distribution going forward.

  4. “It’s also important to note that these rebalancing moves are not driven by market timing, but by a systemic review of asset allocation during the quarterly refill process.”

    Fritz – “Quarterly review – refill process” – I don’t think so! What about we have few years slide down – then what!!! You are propossing to sell equities at the bottom? The answer is naturally, no, but then what!

    I don’t believe in bucket strategy because it will make focus on something that I shouldn’t be focused too much on.

    At the end of any day, I am looking foward in growing my entire “net worth”. Take out money when I need it and move on on fun things in life.

    BTW nice article, but let’s focus on “one bucket” management and make sure it is going in the right direction.

    1. Yes, that’s exactly my concern: Once you draw down the safe bucket too far, you might make an emotional decision and rebalance just at the wrong time – the market bottom. Too much of a whipsaw risk.

    2. “Take money out when you need it” could also lead to having to sell at the bottom, IMHO. I like having the quarterly review process to keep an eye on things (I ignore it at all other times), and often find that there are counter-cyclical positions which allow refill even during a bear (as I did in 2022 and mentioned in the “bear” post linked above). There’s always a risk of having to sell in a downturn, but I believe the 3 years of cash and a formal review process mitigate the risk to the extent possible. I’m also a believer in a widely diversified portfolio, including 10% to Alternatives.

  5. ERN I think you got it right when you said that the bucket strategy is a means of complicating the issue of asset allocation that one may believe they need a financial planner to execute!

  6. Interesting, I haven’t heard of this “buckets” strategy before – I usually associate the term “buckets” with different tax-treatment accounts (IRA vs Roth vs Taxable).

    Karsten’s SAA approach seems more mathematically rigorous, as well as simple, in my mind. However, I think I can see part of the appeal of the buckets strategy Fritz recommends – it seems best suited for overcoming psychological difficulties with spending money in retirement, especially by having a regular “paycheck” that most folks are accustomed to.

    It would be very interesting to see how the average and variance of the two approaches differ for a wide range of historical market returns, as well as the impact on SWR. That could help settle the “which is better mathematically on average” question, even if some folks still find the “buckets” approach more comfortable. Unless you’ve already done that in a previous post Karsten? Perhaps SWR Series Parts 48 and 25? I need to read those more closely.

    1. The problem with the bucket strategy: There isn’t the bucket strategy. There’s only one way to do SAA with monthly rebalancing, but you can model so many different bells and whistles. For what it;s worth, I did a careful analysis for rebalancing your SAA less frequently than monthly See Part 39.
      Not really earth-shaking.
      Main Results
      But you get a very small advantage on average when you rebalance less frequently. It’s possible that a Bucket strategy might go in the same direction.

      1. I think I’m more of a never rebalance guy. Although taking withdrawals “off the top” of the tilted allocation makes some sense. I’m mostly in taxable. I just never seem to see how the different rebalancing styles affects someone in taxable (please consider blogging for both taxable and Roth/IRA portfolios when doing the math). I’d certainly be more open if it was in an IRA without the tax drag.

        1. Depends on the return patterns and your portfolio.
          If you have the “right” account mix, you can certainly do the asset shift only in the IRA/401k/Roth and keep the taxable accounts free from rebalancing and tax drag.

  7. Thank you for this. I love this blog, but then again I did study math a while ago and enjoy google sheets. I like following your logic as you come to a conclusion as to the best way to do things in early retirement. It does seem to me, anyway, like you’ve arrived at a conclusion (at least for now).

    To summarize, use the ER spreadsheet and take into account SS and other planned income and expenses. Use the CAPE ratio on an ongoing basis to determine how much you can spend for any given month. Use a glide path to the retirement date (100% equities to 80%/20% over 5 years) and then after (80%/20% ->100% equities over 5 years). Consider alternative investments like Real Estate (10-15% range). Use SAA to keep the equity percentages at your target.

  8. I am far less experience than either Karsten or Fritz but I plan to execute elements of both.

    Buckets allow me to compartmentalize and let’s me stop my emotions from causing me to do rash things during wild market swings. If I maintain a fixed cash bucket (which includes ultra short term bonds) that can fund 3 years of essential expenses, this makes it easier (psychologically) for the rest of my portfolio to stick to an SAA strategy. So I will always maintain this floor level of expenses in a safe “cash” bucket to keep my sanity. The rest of my portfolio will follow SAA rules (except it will be more aggressive than 70/30).

    I understand this is not totally rationale (money is fungible), but a constant minimum cash bucket provides psychological comfort. I’ve paid off my mortgate early even though I would have increased my net worth more if I borrowed at around 3% and invested in the market because it feels good not to owe anyone. I keep a separate set of assets to dabble in individual stocks even though I am lucky to match the market (with higher volatility so it’s not optimal to do so) but it scratches my itch to play the market so the bulk of my portfolio sticks to a SAA strategy. I’ll likely overweight dividend stocks, REITS and real-estate syndications because I like the dividend cash flows better than selling appreciated stocks to meet my immediate spending needs because spending dividends just feels more like responsible spending.

    At the end of the day, having a reasonable, yet sub-optimal strategy that I’m comfortable sticking with is better than an optimal strategy that causes stress or even worse, may not be consistently followed.

    Finally, since this is a “fight”, my “split decision goes to Karsten” but I’ll still practice some of what Fritz advocates.

    1. UK reader, two years into my retirement journey.

      I started out holding a couple of years’ living expenses in cash, purely for psychological comfort, and despite accepting that over the long term, this would be a drag on growth.

      However, my portfolio is invested in global trackers and is very liquid, and I can sell small amounts to access cash within a couple of days. Accordingly, I have weaned myself off this “cash-heavy” position; I no longer need the cash comfort blanket!

      Once again many thanks Karsten for your wonderful articles (and comments). I’ve been following you for several years now and you have quite honestly changed my life.

      1. Thanks Joe, for the kind words!
        Yes, that’s also exactly my thinking: back the old days it might have taken a phone call, a hefty brokerage fee and several days for you liquidate your equity holdings into cold hard cash. But today I can log in to Fidelity and transfer money out of a brokerage account just as easily as out of a MM account.
        If people want to hold cash, there can certainly be an asset allocation reason, but liquidity is no reason anymore.

    2. Thanks a lot Phillip. Great summary! I can live with people using bukets as a psychological help, to sleep better. But I’m glad that you also recognize the math vs. psychology aspect and don’t expect miraculous results form the bucket strategy.

      Also, I have about 1% of my portfolio in dividend stocks. Play money. Nothing wrong with that either!
      Thanks for sharing your honest opinion!

    3. Phillip, you’re explanation of “a blend” is actually a pretty good summary of how I manage my buckets. In essence, it’s SAA with a focus/priority on the cash allocation. I also agree there are psychological benefits to having the cash cushion. I enjoyed your comment until the last paragraph. 😉

  9. Thank you, Fritz and Karsten for this post!

    Assumptions / Theses:
    – People are different and that is a good thing.
    – People act mixed from logical and emotional reasons.
    – But the range goes from logical Vulcans to emotional divas.
    – Supposedly 20% are rather/majority reason-driven and 80% rather/majority emotion-driven.
    – People do not like uncertainty, but look for reliability, predictability (even if only apparently).
    – People do not like not understanding something. It gives them bad feelings. They are than more afraid
    – People are masters of displacement and postponement
    – People do not change if they do not have to / strongly want to.
    – People are imperfect, poor creatures, driven by fears, greed and emotions.
    – We all need redemption 😉

    Deductions:
    That is why the majority prefers the more emotional bucket strategy and the minority the more logical SAA strategy.
    For SAA you have to be able to calculate a little bit, you have to have a feeling for market histories (or believe Karsten) and you have to make a decision for every single withdrawal (stocks or cash) and implement it (broker), so you have to be rather affine to capital markets.
    For BuckStrat one has the illusion, the first 3 years nothing can go wrong (cash buffer), the next 6 years actually also nothing (bond buffer) and at the latest in 10 years the stock market “will stand somehow higher”. Perceived risks in the future are never as important as perceived risks in the present. The idea of seemingly having to decide less often is appealing.
    The BuckStrat is vividly understandable (Buckets), and the group one can relate to are normal people (instead of math geeks).

    Solution:
    It doesn’t matter if you use the SAA or the BuckStrat or if you think it’s better, the reasons are in your personality. The main thing is that everyone respects each other, because everyone is equally valuable.

    What do you think about this explanation approach?

    Liebe Gruesse
    Joerg

    Translated with http://www.DeepL.com/Translator (free version)

    1. A thoughtful comment, Joerg, and I tend to agree. Different personalities are drawn to different solutions for different reasons. The beauty of “personal” finance is that each can do what best fits their personal style, so long as their reason for doing so is based on knowlege of the tradeoffs.

    2. This is an awesome summary! I cater more to the math geeks, so hence my bias. But I am not going to claim that the BuckStrat is worse in the outcomes.
      Apparently you typed that in German and translated it through an app? Pretty neat! Modern technology is amazing!

      Liebe Gruesse zurueck nach Deutschland! (oder Oesterreich oder Schweiz!)

  10. I think at the end of the day you should follow whatever strategy lets you sleep well at night, but……..

    Professor Estrada at the IESE did a study on static allocation versus bucket strategy from a global perspective.(for those of you that need more math) https://blog.iese.edu/jestrada/files/2019/01/BucketApproach.pdf

    I think his final paragraph says it best:
    “In short, the results discussed here suggest that financial planners should strive to explain to clients the benefits of static strategies relative to those of bucket strategies. They should explain that satisfying the behavioral need of mental accounting imposes a cost in terms of performance. And they should attempt to convince retirees that however plausible, comforting,and easy to implement the bucket approach may be, a static strategy with an appropriate asset allocation would be just as easy to implement and would ultimately make them better off.”

    1. That’s a nice paper! Thanks for the link! Glad that there is more empirical evidence to support my approach.
      I really think that financial advisers should spend that time to ease people’s concerns and explain that the SAA has all of the same features of the BuckStrat, like buy low, sell high, rebalance, buy the dips, etc.

  11. Fritz, I think you made an error in your comment which followed the side-by-side comparison of Bucket v. SAA. You wrote, “By comparing the two approaches, you can see The Bucket Strategy actually results in a slightly higher balance over the three-year period ($1,027,000 vs. $1,025,940), given that no stocks or bonds were sold during the downturn with The Bucket Strategy approach.” Your error, if I’m reading it correctly, is that Karsten’s portion of the side-by-side encompassed only 2 years, whereas yours was 3. Yes, your total after 3 years was higher than his after 2, but if you’d allowed his stocks/bonds to improve during the post-bear recovery like yours were able to do, I believe the math would tip in Karsten’s favor.

    1. Good catch, Casey. I looked it over – the problem is the yellow highlighted title in Year 3, which erroneously reads “Year 2”. The figures in the table are correct, only the title is incorrect. Thanks for paying attention to the detail. Apologies for missing it during my editing.

      1. OK, that’s a good catch then. It’s not a bog deal because I have generated cases where the BuckStrat worked in your favor. It’s relatively easy to generate a $1,000 difference in outcomes.

    2. Well, you can come up with lots of different assumptions and return patterns and some will favor the SAA and some will favor the BuckStrat. Fritz used different returns and came up with a different final outcome, so I trust that his calculations were correct.

  12. So what about the “never-refilled cash bucket” as mentioned in Part 25?

    There you wrote:

    “So, for the record, let me state that this cash bucket strategy seems to work pretty well, despite my previous doubts!

    It’s relatively inexpensive insurance against Sequence Risk!

    Think of it as a mini-glidepath during the first few years of retirement!

    And it ‘only’ takes the flexibility of getting to 27.5x instead of 25x annual spending!”

    I realize it means saving extra (27.5x versus 25x) but you never have to worry about refilling the bucket from your regular portfolio.

    Seems cheaper & easier than paying the price since my portfolio is nearly all in taxable to move from my current allocation (80/20) to 100/0 then to 80/20 then back to 100/0.

    1. As I stated: its a form of a glidepath: You phase out the cash bucket and leave it empty after that.

      My only problem with the BS approach is that people falsely believe that they can market time themselves through a bear market and end up with the SAME asset allocation again as before.

  13. Hello ERN and thank you for all the great information on your blog!

    2023 will be the first year that I live off of my accumulated assets. I’ve spent quite a bit of time working with your Google Sheet establishing an SAA and safe withdrawal rate, so I feel comfortable with my spending budget for 2023.

    Looking forward, is there a place on your blog where you walk through the basic mechanics of adjusting the spending amount for subsequent years? I’m content to take the simplest strategy possible. I plan to rebalance back to the SAA, so my question is merely what are the mechanics of establishing a spending budget for each subsequent year.

    1. If you are already comfortable with ERNs spreadsheet, just reuse it every year subtracting one year from your assumptions. This will get you an SWR you can apply for your budget.

  14. For those of us who are DIY in mostly balanced funds and not separate bonds, stocks, how to rebalance? We have held these funds for years so it seems to me we’d be fine to take money out even in a bear market if needed and just let the funds rebalance themselves. I plan to build 3 years of expenses in cash or Treasuries, then more or less keep that full by pulling out of the balanced accounts each year (or not) based on how the market did. Is that kind of a bucket strategy? Kirsten are you saying I don’t need that much cash to start out and it is an unnecessary drag on returns?

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