Refresher Class: The 3-Bucket Retirement Income Strategy


US stocks rally for the first week in four

US stocks gained 1.4% on the week, though remain down 6.6% on the year, down 10.7% from the May 2015 high, up 64.1% over the last 5 years and up 139.0% from the March 2009 bottom.  The rally was sparked entirely by a reversal in the price of oil, which touched a 12 year low at $26.55 on Wednesday, then rebounded to $32.19.99 by Friday afternoon, an 21% move in 48 hours. 

We would like to think that financial markets are "rational" but every once in a while, markets fixate on ONE particular indicator.  In the last three weeks, price direction in stocks became entirely correlated with price direction in oil.  Nothing else - earnings, interest rates, labor markets, industrial production, housing markets - seemed to matter.  Last August, investors fixated on the Chinese markets, which dragged down US stocks 11% in a month.  When the fixation dissipated, US stocks gained back the entire loss in 2 ½ months.  We expect the same will happen over the next few months, so starting Monday we are putting all our spare cash to work.

Clients want to know: is there a way that we can anticipate times when stock investors will be irrational, step out of the market for a few weeks, then come back in at lower levels.  Many funds and services CLAIM to offer that prognostication, but whenever we inspect their historic records, we see no benefit at all (actually, the results are worse.)  Fortunately, there is a simple asset allocation strategy that enables us to pay our clients' monthly draw no matter HOW CRAZY markets react.  There's nothing magical about this approach - good advisors have employed this strategy for 50 years.  Given that we have an opportunity to catch our breath after 4 long weeks, here is a refresher on:

The 3-Bucket Retirement Income Strategy

Among the 30% of our clients who are retired and depending on their portfolio for retirement, no one has ever experienced a reduction in their monthly draw.  We accomplish this by investing 60-70% of the client's portfolio in higher returning but riskier (more volatile) assets such as US & International stocks, and commodities.  We need the high returns offered by risk assets, or clients will not be able to maintain their lifestyles given that inflation eats away at the lower returns offered by bonds and cash.

We rebalance the buckets once or twice a year, flowing excess balances in the risk bucket to the fixed income bucket, which is invested in lower returning but less volatile corporate & municipal bonds, and preferred stock.  The excess in the bond bucket flows into the cash bucket, which is invested in low risk, low return assets such as money market securities.  Each month, the client receives the exact same draw. 

In general, we have a year's worth of retirement income in the cash bucket, four years in the fixed income bucket, which means we can survive a 5 year "drought" in risk assets, which is exactly what happened during the 2007-2010 period of financial turmoil.  For a few months, the usual 60- 70% in risk assets shrank to 50% or even 40%.  We simply stopped the rebalancing process for a year or two, waited until stocks regained new highs (by 2011) and then continued as usual.

The benefit to our clients of this process is that you can dispassionately observe these weeks of market stress knowing that you will continue to receive your monthly draw, and can enjoy your life.