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How's Your Stability Bucket?
You may have heard that volatility has returned to the stock market.
Year to date, the broad based S&P 500 is down more than 8% while the tech-heavy NASDAQ is down more than 13%. Intraday volatility has been particularly high, with major indexes shifting more than 3% within a single day's trading.
While this may seem highly volatile, it's actually quite normal. In fact, in most years the market declines meaningfully at some point during the year (the average intra-year decline is 14%) even though the market ends the year with positive returns 75% of the time.
Knowing the facts about volatility is one thing. Actually experiencing that volatility, particularly when your entire life savings is invested to support your retirement income, is quite another thing. That's why we have a Stability Bucket in Power of 5 Investing.
Stability Bucket Defined
We believe portfolios should be built in anticipation of volatility, not in response to it. Our “Stability Bucket” is a disciplined approach to taking the emotion out of retirement investing. We determine your withdrawal needs for the next five years and immediately set those aside in a low-volatility Stability Bucket. Any remaining assets are invested for longer-term appreciation in a diversified “Growth Bucket.” In a bear market, the money in your Stability Bucket will help you ignore the temptation to sell growth investments at fire-sale prices.
What Belongs in the Stability Bucket?
Only short-term instruments with an explicit guarantee of principal, or a very unlikely loss of principal over the next 5 years. In addition, these must be fully liquid funds. Traditionally this has included instruments like:
Certificates of deposit (CD's)
Money market funds & commercial paper
Short-term US Treasuries, or funds comprised of Treasuries
What Can I Earn on the Stability Bucket?
It's no secret that the Federal Reserve has been actively intervening in financial markets to manage the level and direction of interest rates. The Fed went to unprecedented lengths to prop up markets during The Great Recession of 2008, began to disentangle itself in the late 2010's, then threw its weight around considerably to combat the effects of COVID-19. The net effect of the Fed's intervention has been to artificially suppress the natural level of short-term interest rates. This is why retirees and savers face such paltry yields on bank deposits, certificates of deposit, money market funds and other short-term instruments. The Fed continues to reward borrowers while punishing savers.
Given the current state of interest rates and Federal Reserve intervention in short-term markets, we are seeing very low yields on the Stability Bucket. We tell retirees to expect around 1% on their Stability Bucket holdings.
How Is a Retiree Supposed to Live on 1%?
You can't. We believe most retirees can reasonably withdraw 4%-6% off their retirement portfolio and, if that portfolio is properly designed, take those withdrawals without worrying about running out of money. That's why we pair our Stability Bucket with a quality longer-term Growth Bucket.
How Stability and Growth Work Together
We find most retirees, across an average 30-year retirement, earn annualized returns north of 7% even after factoring in fees and expenses. Here's the math:
$1 million retirement portfolio
5% safe withdrawal rate (i.e. $50,000/year of withdrawals)
5 years' of upcoming withdrawals ($50,000/year * 5 = $250,000) allocated to the Stability Bucket
We find most retirees consistently following the Power of 5 Investing philosophy actually grow their wealth in retirement, rather than shrinking it. This makes sense when you consider the portfolio is earning 7% while the client is withdrawing 5%. Portfolio returns don't happen in a predictable straight line, of course, hence the need for some additional return cushion during lean years in the market.
The Stability Bucket "Superpower"
Particularly when times are good, clients may wish they had more of their portfolio allocated to the Growth Bucket instead of the Stability Bucket. They may feel defeated that they're "only earning 1%" on their Stability Bucket.
Frame of reference is important here. The Stability Bucket's "superpower" isn't what it yields when the stock market is up; it's that it keeps you from panic selling your Growth Bucket holdings at fire sale prices when the stock market is down. In doing so, the Stability Bucket's return might be many multiples of 1%.
In much the same way that we buy homeowner's insurance to protect us financially if our house burns down, the Stability Bucket is there to protect us financially if (when) the market melts down. The Stability Bucket is a powerful form of retirement portfolio insurance that every retiree should have.
How's Your Stability Bucket?
Do you have a Stability Bucket for retirement? Is it big enough? Is it too big? What's it invested in? How often do you refill your Stability Bucket? What about taxes on investment sales?
Our retirees know how important their Stability Bucket is, and they know where it stands at all times.
We've been helping clients prepare for, and thrive in retirement for over three decades. Our clients' continued financial success is exceeded only by their success at the game of life.
When we build retiree portfolios at Oxford, we seek a balance between Stability and Growth following the principles outlined in our proprietary Power of 5 Investing system. Our goal is to help clients achieve inflation-beating growth in their wealth, while managing through market downturns, ultimately helping clients leave a legacy to the people and places they love. Our system has been battle tested in 25+ years of market ups and downs and is ready for whatever the market can throw at it.
If you don't know the answers to the questions above, we can help. Click the button below to setup a free Get Acquainted meeting.