Buckets

Published On: February 27, 2020

Written by: Ben Atwater and Matt Malick

During periods of market turmoil, like the one we’re currently ​enduring as a result of the coronavirus outbreak, it can be helpful to think about your investment portfolio in terms of buckets.

Our investment approach ​is built on a foundation of two broad asset classes: equit​i​es and fixed income.  Equities, on the one hand, are volatile but provide high expected long-term returns.  Fixed income, at least the sort of high-quality bonds that we buy on clients’ behalf, are ​generally stable and generate steady cash flows but come with low expected average annual returns.

​As you contemplate the impact a protracted bear market could have on ​your financial goals, we think it’s important to focus on these two buckets.  As we determine each client’s appropriate mix between equities and fixed income, we always consider future cash flow needs.

For example, let’s consider a hypothetical client, a couple with $2 million in investable assets that is preparing to retire this year.  Based on our retirement projections, these clients expect to spend $120,000 per year in retirement and their Social Security benefits will cover $60,000 of the total.  This would leave a $60,000 per year shortfall to cover with ongoing withdrawals from investments, which represents a manageable 3% withdrawal rate.

During the 2007-2009 Financial Crisis, which caused the worst recession in almost 80 years, the S&P 500 tumbled about 57% over a 17-month period.  It took another 49 months for the index to recover its losses and reach new all-time highs.  Altogether, the bear market and recovery took 66 months, or 5 1/2 years.  (Our retirement planning software, MoneyGuidePro, uses the Financial Crisis to “stress-test” client portfolios and we believe it’s a fair estimation of the worst kind of bear market that clients should expect during retirement.)

Based on annual withdrawals of $60,000, our hypothetical client would need $330,000 allocated to fixed income, or roughly 16.5% of their portfolio, in order to completely avoid forced stock liquidations if a similar bear market and recovery occurred now.  Our typical retiree client has a significantly higher allocation to high-quality fixed income and could “wait out” an even longer bear market and subsequent recovery.

Nobody knows how long this correction will last and whether it ultimately leads to the end of this great bull market.  And we know that timing the market is impossible.  So, it’s best to stand pat while taking comfort in the fact that we’ve customized a portfolio for each client that affords enough safety and liquidity to wait for markets to recover.