How The Bucket Approach Can Help You Navigate Market Volatility
Let’s briefly think back to 2008, when the world was “falling apart” at the hands of the latest devastating (albeit temporary) market correction. The S&P 500 ended that year down roughly 38.5%. The uncomfortable joke around many offices was that a “401(k) is now a 201(k)” as the markets pillaged all those who were in them.
But now it’s 2019, and history has shown that was only a temporary occurrence. Retirement accounts bounced back, but it took a few years. The recovery was longer and slower than any on record, but it occurred, like recoveries always do. Not only did one occur, but it launched the start of the cyclical bull market run in history (one that is still going on).
All that said, some investors missed the boat. They got out when the market finally went into “on sale” mode. Some missed the start of the recovery process and have yet to still get back in (a decade later). So what lesson can be learned from this? That emotions need to be managed as much as any portfolio does so that investors don’t get in the way of their own success.
The market has shown some pretty consistent trends and averages. If you look at the S&P 500 over the you will see some interesting trends in the market’s movement:
• Daily dips in the market of 2% or more occur about five times a year.
• The S&P 500 averages at least one nearly 14% drop per year.
• There is a drawdown in the markets of at least 30% every five years.
Yet the markets rise roughly 3 out of every 4years, and over long periods, stock market returns significantly beat inflation.
So why does it shock investors so much when corrections occur? It may simply be out of your control; it may be part of your DNA. A good way to think of it is a story I once heard about humans’ ancestors. Two people were in search of food and water, walking side by side down a path lined with trees. Suddenly, they heard a rustling in the brush. One of them stopped immediately and ran back to the safety of his camp. The other stayed to see what was making the noise. Sure enough, only one of these two survived that day (the one who ran), and a lesson was forever imprinted on that person that was then passed down for years and years. Survival, and running from fear, is as human as it gets. Our brains are wired that way.
So knowing that, how can investors handle the fear, unknown and volatility of the financial markets? Although the markets’ past is no indication of their future, you can put together a plan to navigate them based on the best information available — their history.
See, while a person is working and therefore adding money to their retirement savings, it’s much easier for them to comprehend that if the market is temporarily down, they are in essence “buying low,” which people know to be a good thing. But if that person is nearing the point of having to use this money to supplement their income, seeing the market and the value go down can be tough to stomach — even if they know it’s only temporary.
One strategy for combatting this discomfort, which my firm uses with many of our clients, is called the Bucket Approach to retirement income streams. It involves three portfolios for a person’s assets and goes like this:
• Preservation Portfolio Bucket: The goal of this bucket is safety in down equity (stock) markets. This portfolio includes a combination of money market and bond funds that will help maintain an investor’s purchasing power by helping their money keep up with inflation. An investor places two or three years of required retirement income in this so that if the stock market is down and in a prolonged correction, they can live on this and not have to sell — and in turn lock in a loss to — any of their equity positions.
• Income Portfolio Bucket: Since most years the equity markets are up, as noted above, during most years an investor can take their annual income needs from this more moderately invested mix of assets. But, if and when the market hits a rough spot and the investor doesn’t want to sell from this, they don’t have to. And they don’t have to guess when that is going to be. They can simply look around at the time in which they need to get the income and clearly see that pulling from this account while it’s down is not a good idea. They then can take their income from the Preservation Portfolio and ride out the subsequent market recovery until they are back to where they were before it occurred. Then they resume taking their income from this portfolio.
• Growth Portfolio Bucket: Of the 3 out of 4 years the market is positive, some of those years are very positive. Therefore, this mix of assets is much more heavily weighted in the equity markets. During up years, the investor can harvest the gains and replace what they’ve spent out of the other two buckets. During down years, the investor should ignore this account, because it will be down the most. But they can be comforted knowing the market will rebound in time.
I’ve seen this method hold up over time and believe it helps investors to stay the course, not blow their investment plan up at the wrong time, and ultimately have a much smoother and less anxious ride toward retirement.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
