Stan's World - The Bucket Approach

S.F. Ehrlich Associates |

February 15, 2019

Financial planning is part art and part science. The science portion relates to the use of academic studies to construct portfolios with various levels of risk that can be used to provide retirees a certain level of income for their lifetime. The art element is equally important because we deal with individuals, and each individual has unique needs, disciplines, and tolerances.

While we know that the stock market historically goes up more than it goes down, we never know how it will perform on any given day, week, month, or year. In response to the reality we find ourselves in every day, we build portfolios that attempt to address client needs for both the short and long term. To accomplish that task, we use the concept of buckets, deliberately designed to protect investors from severe market shocks. (Younger investors, with a significantly longer time frame ahead of them, don’t require too much protection from market volatility.)

Christine Benz, the well-respected Director of Personal Finance for Morningstar, recently wrote1  that 2018 was a great year for the bucket strategy. “(L)ackluster to horrible years like 2018, 2009, and 2002 underscore the virtue of maintaining a cushion of safe assets to use for expenses. Importantly, that cash cushion would prevent a retiree from having to raid depreciated stock or bond holdings to pay the bills. Additionally, holding a component of cash and short-term bonds might even allow for adding to depressed stock and bond positions during periods of market weakness.”

In our practice, Bucket 1 is filled with cash and/or money market assets to fund annual expenses for the ensuing 12 months. Bucket 2 contains money market funds and/or short-term bond funds, set aside to fund years 2-5. Bucket 3 may include multi-sector bond funds, designed to fund expenses for years 6-10. The final bucket, Bucket 4, is filled with equities. The strategy is to use the less volatile buckets (1-3) to fund cash flow needs should the equity markets fall and require time to recover.

A rising stock market allows for Bucket 4 to ‘pour’ into the other buckets. As markets don’t always rise, the strategy includes receiving dividends paid by mutual funds as cash (as opposed to being reinvested into mutual funds or stocks) to allow us to add to Buckets 1-3, even during down years.

But the practice of adding safety to a portfolio comes with a cost. It states the obvious to say that in those years when stock markets run, the fixed income, cash, and money market funds in Buckets 1, 2, & 3, are a drag on performance. That means if Bucket 4 goes up 20%, it’s highly unlikely that Buckets 1, 2 & 3 will do the same. But when markets fall, there’s nothing better than knowing that there’s a large parachute to slow down the drop and ensure cash will be available next month and for years thereafter.

I’ve used this line too many times, but it rings true when talking about how we invest for our clients. We’re not here to make you rich; we’re here to make sure you don’t become poor.


1 Benz, Christine. “Bucket Portfolios Faced a Real Stress Test in 2018.” Morningstar, 7 Feb. 2019,
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