There is a popular investing plan called “Investment Buckets.” It is a retirement strategy where investments are segregated into three groups based on the time when the investor anticipates needing the asset for retirement expenses: Now, Soon, Future. I utilize a similar approach of asset allocation, but with a twist.
A twist on the retirement bucket strategy
Morningstar describes the bucket strategy as:
The bucket approach to retirement-portfolio management, pioneered by financial-planning guru Harold Evensky, aims to effectively help retirees create a paycheck from their investment assets. Whereas some retirees have stuck with an income-centric approach but have been forced into ever-riskier securities, the bucket concept is anchored on the basic premise that assets needed to fund near-term living expenses ought to remain in cash – dinky yields and all. Assets that won’t be needed for several years or more can be parked in a diversified pool of long-term holdings, with the cash buffer providing the peace of mind to ride out periodic downturns in the long-term portfolio.
Kiplinger describes the bucket approach as:
You divide your retirement money into three buckets: One is for cash that you’ll need in the next year or two, including major expenses, such as a vacation, a car or a new roof. The next is for money you’ll need in the next 10 years. The final bucket is for money you’ll need in the more distant future, either for you or your heirs. The bucket system “gives you the confidence and peace of mind to stay the course,” says Jason Smith, author of The Bucket Plan: Protecting and Growing Your Assets for a Worry-Free Retirement.
Personally, I consider myself retired, even though I derive income from my labors as a financial writer. My monetary concerns are the same as 44.5 million other retired workers receiving Social Security benefits – will I run out of investments to fund living expenses for myself and my wife before we pass? Through smart investment decision-making now, in the past, and in the future, I anticipate the answer is: No.
Overall, I consider myself a value investor. According to the Morningstar analysis tool, my total portfolio of equities is considered 57% Value, 27% Core, and 16% growth.
I like the concept of buckets to visualize assets to be used for specific purposes. Back in the very early 20th century, Grandfather Fisher preached and implemented the “envelope” approach for his paycheck to allocate earned income for specific expenses, and the bucket approach is merely an update of that financial strategy: asset segregation based on time or need. My twist is to meld the two – allocation based on an asset’s purpose within the portfolio and asset buckets tied to specific time frames and expenses. I maintain five buckets/envelopes titled:
Cash. This includes money market funds, a ladder of bank certificates of deposits CDs with maturities no more than 24 months, and a very short-term bond fund with very low duration of 0.24 (sensitivity to interest rates) and weighted average maturity of 4 months (0.29 yrs). This bucket also provides what Mr. Buffett refers to as the “optionality of cash” or having sufficient cash to take advantage of unforeseen investment opportunities.
Bonds. In the current low-rate environment, bond principal protection should be paramount, which equates to owning shorter bond maturities. Understanding the pitfalls of yield chasing, my total bond exposure is a ladder of date-specific investment grade (vs. high yield or Treasuries) corporate bond ETFs with the last rung maturing at the end of 2026.
Equities bought primarily for capital gains. When I decide to invest in a company through common stock ownership, it is usually with an eye on future capital gains or distribution/dividend income or both. To keep it simple and to home in on the overriding purpose of the investment, I have two major equity buckets, and this one is for stocks and ETFs bought with the dominant anticipation of generating medium- and long-term capital gains, with generally a 3-year investment horizon. As investment income is a substantial portion of many investments’ long-term total return, and with a paramount goal of a total portfolio generating consistent spendable income, many of the investments in this bucket are also dividend payers.
Equities bought primarily for distribution/dividend income. This bucket includes common and preferred stocks and ETFs that are bought primarily for the income they generate. These include higher-yielding stocks, such as out of favor companies with higher than average current income, utility stocks, and master limiter partnerships. While many components of this bucket will have capital gains potential, gains become the icing on the cake of ownership for these positions.
Speculative, high risk investments. This bucket includes stocks, bonds, and MLPs which are considered high risk, high reward, usually in the small-cap realm. While bought for the same reason as the other equities categories, these selections are usually added with a shorter investment horizon and/or in anticipation of a specific trend-changing event.
Currently, my personal portfolio is allocated as: Speculative 2.0%, Bonds 14.2%, Cash 17.7%, Equities bought primarily for capital gains 29.1%, and Equities bought primarily for income 37.0%. The total portfolio consists of 68 individual positions, 26 of which fall within the Equities bought primarily for capital gains bucket.
While trying to maintain sector diversification, a health slug of utility stocks and energy MLPs within the income bucket creates an overall portfolio over-weighting in these two sectors. Some of these holdings have been in the portfolio for many years, and although currently the selection may be rated as 2 or 3 Stars by either Morningstar or CFRA, or market weight and under-perform by Credit Suisse and others, I believe their position creates value for the portfolio.
In addition, my investment style is to usually nibble in and nibble out, and a smaller current allocation could be from either building a position over time, from exiting a position over time, or the small position could be from taking profits and letting the “house money ride” for an extended time frame. The question becomes where to categorize stocks with both income and capital gain attributes? I have an inexact threshold of a 5% to 6% (and higher) sustainable current yield as the separation point.
Below is a table of stocks and ETFs, listed by sector and position value, I own in the bucket titled “Equities bought primarily for capital gains.” If one were to look at the M* Investment Style chart, many of these selections fall into the Value boxes.
Source: Guiding Mast Investments, morningstar.com, thomsonreuters.com, tdameritrade.com
The top six positions in this bucket are United Technologies (UTX), the Morningstar Wide Moat ETF (MOAT), CVS Health (CVS), Northrop Grumman (NOC), Mercer International (MERC) and the Equal-Weighted S&P 500 Index ETF (RSP). Combined, these comprise 29.8% of this bucket.
The M* Rating is based on a 1-5 Star rating, with 5 being a buy, 3 being neutral; CFRA Quality Rank is a rating for 10-yr consistency in earnings and dividend growth, with A+ being the highest, B+ being average. Many of these stocks are incorporated in our Guiding Mast Investments stock universe, which identify stocks with a combination of low forward PEG ratios, above-average forward earnings yield, higher current distribution yields, a strong history of generating investor returns through higher earnings and dividends, and are well-liked by analysts.
I usually track past total returns and anticipated total returns over the next 24 months. When the investment reaches my goal and the anticipated total return begins to decline as price targets are met, the position is reviewed for potential trimming, and in some cases elimination. There is also a weeding out process for selections which did not meet their anticipated returns, especially during the tax-loss harvesting time of Oct and Nov for taxable accounts.
I hope readers will glean a few nuggets from this list, as many of the above selections I would continue buying and recommending, especially during times of overall market weakness.
Full Disclosure, I am long all stocks mentioned in this article.
Author’s note: Please review the disclosures on my SA profile page.
Disclosure: I am/we are long CVS, UTX, MOAT, MERC, NOC, RSP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.