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A Sample Retirement Portfolio for Moderate Investors

For investors with 20-year time horizons, this portfolio includes a good mix of shorter- and longer-term holdings

Christine Benz 8 November, 2012 | 9:51AM

My previous "bucket" portfolio that I outlined in an earlier article is probably a far cry from your grandparents' retirement portfolio. Developed for a hypothetical retired couple with a 25-year time horizon, the portfolio acknowledges that increasing longevity rates mean that most retirees will need a healthy equity stake for growth potential. And in a bow to today's low-yield environment, the portfolio relies on a total-return approach rather than maintaining an income-only strategy.

But not every retiree has a 25-year time horizon and the high risk tolerance that would make such a portfolio a good fit. So this time around, I'll show how the bucket concept can be adjusted to suit a couple with a slightly shorter time horizon--20 years--and a somewhat lower capacity to withstand the sometimes-extreme return fluctuations that accompany stocks.

Bucketing Basics

Bucket retirement portfolios are appealing on a couple of levels. By staging the portfolio by time horizon--which is the key point about bucketing--you can afford to ride out the volatility inherent in stocks and more aggressive bond types because you know you won't need to touch that money for several more years. My construct includes a safe, liquid bucket for near-term income needs; an intermediate-term bucket that will eventually cover expenses during the middle retirement years; and a long-term bucket consisting mainly of stocks for the later retirement years. Assets are periodically moved from buckets 2 and 3 into bucket 1 to help meet income needs.

A bucketed portfolio also differs markedly--and in my view, for the better--from one that anchors exclusively on income-producing securities. Income-producing stocks and bonds are well-represented in my bucket portfolios. But if the portfolio's income level falls short of the retiree's target for living expenses, he or she can look to rebalancing and tax-loss proceeds to refill bucket 1. The advantage of the total-return approach is that it enables a retiree to build a more diversified portfolio: the portfolio should have more attractive long-term risk/reward characteristics instead of being anchored exclusively in high-income stocks and bonds.

Assumptions

For this sample portfolio, I am using a hypothetical retirement situation where I will assume that I am working with:

  • A married couple with a 20-year time horizon and a moderate risk tolerance
  • £1 million in total portfolio assets
  • A 5% initial withdrawal rate, meaning that they will withdraw £50,000 of their portfolio in year 1 of retirement, then inflation-adjust that amount in each year thereafter. (Assuming a 3% inflation rate, the year 2 withdrawal would be £51,500.)
  • The couple wants to spend all their money during their lifetime and do not plan on leaving a legacy
  • They hold all of their assets within a tax-sheltered account. (Those with large shares of their portfolios within taxable accounts will need to pay greater attention to the tax efficiency of their holdings.)
  • The retirees will take a strategic approach to their portfolio management (that is, long-term and hands-off) rather than employ a more tactical strategy. They will regularly move assets from buckets 3 to 2 and 2 to 1, a process that will make the overall portfolio more conservative over time.


5% vs 4% Withdrawal Rate

At first blush, that 5% withdrawal rate would seem to be overly aggressive, given that it's higher than the 4% withdrawal rate that is generally deemed to be safe. But the research supporting the 4% rule employed a 30-year time horizon. More recent research suggests that retirees with time horizons shorter than 30 years might safely nudge their withdrawal rates higher.

It's also worth noting that bucketing a retirement portfolio allows for a lot of flexibility. For example, although I've provided specific pound amounts below, they can be readily adjusted to suit smaller or larger portfolios. Moreover, the portfolios don't require you to start from scratch by scrapping your existing holdings. For those with reasonably well-diversified portfolios consisting of sturdy core positions, those can be readily swapped in instead of the specific funds I've mentioned below.

Bucket 1: Years 1-2

£100,000 (10%): Cash: This includes cash, money market accounts, savings accounts, and so on

This part of the portfolio is designed to meet the couple's income needs for years 1 and 2 of their retirement, so its goal is liquidity and stability. Therefore, it includes true cash instruments.

An example of a suitable money market fund would be the Invesco Perpetual Money Fund.

Bucket 2: Years 3-12

- £150,000 (15%): M&G UK Inflation Linked Corporate Bond GBP Fund
£150,000 (15%): Fidelity Strategic Bond Fund (Rating: Silver) 
- £75,000 (£7.5%): Fidelity Global Inflation Linked Bond Fund
- £125,000 (12.5%): Invesco Perpetual Distribution Fund (Rating: Gold) 

This component of the portfolio is geared toward providing income for living expenses once bucket 1 is depleted. The name of the game here is income production, stability, and inflation protection, as well as modest capital appreciation. This portion of the portfolio includes a high-quality, short-term corporate bond fund to tap once bucket 1 is depleted; here I've used a relatively newly launched fund from M&G, which will tend to have limited interest-rate sensitivity and also offer a measure of inflation protection. 

The Fidelity Strategic Bond fund is the portfolio's linchpin fixed-income position. Although all bonds could be vulnerable in a rising-rate environment, its flexibility to adjust its interest-rate sensitivity and venture into various bond-market sectors is attractive. The Fidelity Global Inflation Linked Bond fund, meanwhile, provides a measure of inflation protection, though it's also likely to be the most interest-rate-sensitive piece of the portfolio. Finally, the portfolio includes a dash of dividend-paying equity exposure via the conservative-allocation vehicle Invesco Perpetual Distribution fund, which combines a 70% bond weighting with a 30% value-oriented equity stake.

Bucket 3: Years 13-20

- £100,000 (10%): Invesco Perpetual High Income Fund (Rating: Gold)
- £100,000 (10%): Fidelity MoneyBuilder UK Index Fund
- £100,000 (10%): Newton Global Higher Income Fund (Rating: Silver)
- £50,000 (5%): Kames High Yield Bond Fund (Rating: Silver)
- £50,000 (5%):  M&G Optimal Income Fund (Rating: Silver)

Bucket 3 is the growth engine of the portfolio and it focuses largely on stocks. It uses Invesco Perpetual High Income as its anchor; although that fund's dividend yield isn't high compared to other equity income funds, its focus on companies that have a history of earnings stability gives it a high-quality, low-volatility emphasis. The portfolio also includes a broad stock market index tracker, which is the Fidelity MoneyBuilder UK Index Fund. Newton Global Higher Income provides a high-quality take on overseas markets, focusing on companies with sustainable competitive advantages and strong balance sheets. Two niche holdings round out the portfolio: M&G Optimal Income fund supplies high-quality, whole-of-market fixed-income exposure, while Kames High Yield Bond Fund invests solely in the high-yield bond market.

This sample "bucket portfolio" was created with help from the Morningstar Investment Management Europe team. The original American version of this article can be found here.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

About Author Christine Benz

Christine Benz  is director of personal finance at Morningstar and author of 30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances.