Reta Lancaster worries a lot that she or her husband, Richard, will be stricken by the new coronavirus. But the retired Indianapolis couple haven’t had a moment’s worry about paying their bills.
The couple, who spent careers in teaching and nonprofits, proved to themselves during two bear markets since 2000 that a large cash stash and what’s known as a “bucket strategy” would get them through the cruelest of markets. And it seems to be working again during the market’s abrupt turn from near record highs to a nearly 35% drop at one point in recent weeks.
“We really are feeling fortunate,” said the 88-year-old Reta, contrasting her peace of mind with retirees whose savings have been savaged during the coronavirus crisis.
A typical iteration of the Lancasters’ strategy includes three buckets designed to give retirees long-term growth potential as well as a stash of cash and liquid investments that can be drawn upon for living expenses and as a bulwark from having to sell stocks in a market downturn.
In the first bucket, a retiree typically has at least two years of cash for any expenses no matter what the stock market does.
A second bucket, containing primarily bonds, provides another safeguard—a stash to get through a stock-market beating as Treasuries typically act as a haven when equities are tumbling. As time goes on, bond income via interest or through maturity replenishes cash that’s been spent from the first bucket.
The third bucket is key: This is where stocks go to provide more long-term growth than bonds or cash, while also potentially yielding cash dividends for use in the first bucket. When a market downturn comes, however, this bucket can be left untouched until stocks rebound.
Christine Benz, director of personal finance for Morningstar, examined the impact of the market tumult on a prototypical bucket strategy in late March. Her conclusion: The third bucket made up of stocks was awful, but that was to be expected. The second bucket of bonds, which are supposed to be relatively safe, had been hit with some “worrisome” losses.
But investors were pacified by their cash, Benz said. “Now is the bucket portfolio’s time to shine. It’s giving people comfort,” she said, and keeping people from bailing out of deep losses on the riskier stock investments they will need over time.
Benz contrasts this volatile period with times when stocks are steadily climbing. During long rising markets, Benz said, investors look at stock gains and question why they should keep two years of cash out of stocks and bonds. Some studies have questioned the strategy, too, because sizable cash stashes can deprive retirees of the growth they need to make portfolios last for 20 or 30 years.
What’s more, bonds have provided meager income in recent years and haven’t always performed as expected during recent downturns. In 2018, bonds were a disappointment and in March, safe Treasuries fell along with stocks at a certain point although they have been cushioning stock losses recently.
“The long-held belief that bonds give you a hedge against a fall in stocks is not always true,” said Patrick Leary, head of trading for InCapital.
While the bucket approach is used by many financial planners, the design of the buckets varies. Some financial planners in the first bucket want cash to last three years in case a long bear market occurs. Others are satisfied with one year. Advisors differ on investment choices, too: Some stick to federally insured savings accounts and certificates of deposit for cash, while some take on a little more risk with money-market funds and short-term bond funds.
We really are feeling fortunate.
In the second bucket, bonds and bond funds are key because they replenish cash as retirees spend the money they originally had stashed away in bucket one. But there is no universal prescription. Advisors usually pick a mixture of bond types, but some lean toward safe U.S. Treasury bonds and top-quality corporates, while others try to boost income with larger exposures to riskier corporate bonds and small allocations of dividend-paying stocks.
This second bucket has been a particular thorn in recent years for many financial planners, who say they have been struggling to hold relatively safe bonds that will provide enough income to replenish the cash retirees need. Ten-year Treasuries, for instance, were recently yielding around 0.70%, compared with 1.6% early this year.
Yet higher-yielding bonds—everything from corporate bonds, to floating rate bank loans, mortgages and municipal bonds—have been dicey as the coronavirus crisis has pummeled the economy. For example, the
iShares iBoxx $ Investment Grade Corporate Bond ETF
(LQD), lost 21% between March 6 and March 19.
Meanwhile, financial planners say they are sticking with well-diversified portfolios and the security their clients have from large amounts of cash to ride out the coronavirus lockdown.
“Most people have 10 or more years to ride out the storm, and during that time money comes to them virtually every month,” said Marc Hadley, the Lancasters’ financial planner.
If this crisis goes on long enough, though, Long Island financial planner Larry Heller said he might need to suggest some clients reduce their spending. That happened in the financial crisis as the market fell 57% and people panicked and demanded an escape from stocks.
Yet retirees appear positioned well and no one has asked him to sell stocks, Heller says. “They get a check every month so they don’t worry,” he said. “They can sleep.”
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