Scratch Pad: Buckets of money

Introduction
Buckets of Money is a phrase used by author-advisor Ray Lucia to refer to his retirement withdrawal system. It was originally described in his 2004 books, Buckets of Money: How To Retire in Comfort and Safety, and later in The Buckets of Money Retirement Solution: The Ultimate Guide to Income for Life (2010, Raymond J. Lucia and Ben Stein). He operates an advisory service, RJL Wealth Management, which counsels and manages client portfolios, using a system with the trademarked name Bucket Strategy™.

SEC charges of misleading information
On September 5, 2012, the SEC issued a cease-and-desist order, charging Lucia with "spreading misleading information about his Buckets of Money strategy" at seminars for clients. Specifically, the SEC says that Lucia represented that the strategy as "science, not art," "empirically" verified, and that he had "backtested it over several bear markets, including the dismal period beginning in 1966" and that it had succeeded in all of them. The SEC says that the backtesting was cursory, incorporated optimistic assumptions, and when they tested the strategy using actual historic values for inflation and REIT returns, it failed:
 * ...Respondents disclosed that they used a hypothetical 3% inflation rate, although they used actual historical data for returns on stocks and bonds. Lucia admittedly knew that using a lower inflation rate for the backtests would make the results look more favorable for the BOM strategy. Moreover, actual figures for the inflation rate during the time period 1966 through 2003 were readily available from the Department of Labor when Respondents performed the calculations in 2003.


 * When historically accurate inflation rates are used in the alleged 1966 and 1973 backtests, an investor using the BOM strategy would have exhausted his or her assets by 1986 (if retiring in 1966) or by 1989 (if retiring in 1973)...

The strategy
The "Buckets of Money" strategy is one of many "systematic withdrawal systems" for drawing money from a portfolio during retirement. Like many such strategies it has received interested attention within the forum. It has never been specifically recommended as part of the Bogleheads investment philosophy, and is not mentioned in The Bogleheads' Guide to Investing or the Bogleheads' Guide To Retirement Planning.

Conceptually, what makes the "buckets" strategy different from others is that the portfolio is not treated as a whole, but is segregated into three separate portfolios or "buckets." RJL Wealth Management has a conceptual presentation of the current version of the strategy. Lucia says:
 * Stripped to its simplest form, here's the premise of the Bucket Strategy™: You organize your investments into three main groupings, or "buckets" and take the majority of the risk in Bucket No. 3, largely with stocks and real estate. You live by spending down the first two, relatively "safe" buckets; meanwhile, you don't touch that third bucket.


 * The strategy is designed to "buy" time by having reliable sources of income in retirement while you allow your stocks and real estate to grow for 15 years or more, all with the aim of reducing the risk that's inherent in stock-market investing.

When buckets 1 and 2 are exhausted, they are refilled from bucket 3. The idea is that because bucket 3 is not required for 15 years or more, there will be time to ride out a bear market. An important point, however, is that because the safer assets are being tapped first, the third bucket becomes a larger and larger percentage of the total portfolio; the stock allocation actually increases with age. Notice that this runs counter to the usual "de-risking" strategy used in e.g. target retirement funds in which the stock allocation "glide slope" decreases continually with time.

Lucia's claims for the strategy
Lucia emphasizes the alleged safety of his method. In his words:
 * A more foolproof way must be found to achieve financial success. It needs to be a method that with a high degree of certainty that, if implemented properly, will work under the stress of world wars, recessions, and the like. I believe it's possible to bullet-proof your retirement. But the key is found not in the art but in the science of a money-management strategy.


 * The science of asset allocation--in particular the Buckets of Money approach--has been time-tested.

The SEC says that any such "testing" was sketchy and invalid. So whether or not the approach is sound, Lucia failed to provide good evidence of its soundness.

Criticism of the strategy
Many Bogleheads who have looked at this have concluded that it is just another withdrawal strategy. One can argue over whether it might be marginally better or worse than some other method, but there is nothing special about it. It appears to be just one way of implementing a so-called "bonds first" strategy, which has been studied by researchers (Weigand, Robert, and Robert Irons, 2008, "When Does a bonds-first Withdrawal Sequence Extend Portfolio Longevity?" Journal of Financial Planning November 2008: 66-77).

Moshe Milevsky analyzes the "buckets" approach in an article entitled Can Buckets Bail Out a Poor Sequence of Investment Returns? and states that:
 * These strategies are an optical illusion at best and create a potential for grave disappointment at worst....


 * If you decide to adopt the so-called buckets approach to retirement income planning then beware of the fact that your total asset allocation and implicit exposure to equity will fluctuate unpredictably over time. Moreover, if indeed you experience a poor initial sequence of investment returns – so that you have been forced to liquidate all your cash investment--you might find yourself with a 100% equity exposure well into retirement and possibly deep into a bear market. This is in contrast to the non-bucketer... who is maintaining the same exact asset mix and hence the same risk profile over time. Sure, the market may recover by the time you have to tap into the equity portion – or it may not.


 * Either way, you have neither reduced nor mitigated financial risk but simply taken a bet on scenarios you believe will not happen. Safety is just a mirage.