Financial advisor Harold Evensky pioneered the cash bucket strategy in 1985 so that customers would remain calm during market declines and not be forced to sell exhausted stocks to withdraw money. He originally told clients to keep two years’ worth of additional living expenses in the money bucket, but later reduced that to one year’s worth.
Evensky, now 79 years old and retired from planning, disagrees with the way the bucket approach is commonly used today. Some advisors hold up to 10 years of living expenses in short- and medium-term buckets, and long-term investments in a third bucket. Evensky prefers his simpler two-bucket approach: one for cash, the other for long-term investments. He says a year’s worth of cash is enough to protect investors from market volatility, and holding more will drag returns.
Evensky, who has a degree in civil engineering and taught personal finance for years at Texas Tech University in Lubbock, Texas, also opposes some of the conventional wisdom in personal finance. For starters, Evensky disagrees with the belief that people naturally spend less after they retire; he says they spend less, mainly because they have less. If they saved more while working, they’d spend more in retirement, he says.
We reached him at his house in Lubbock. His comments have been edited.
Barron’s Retirement: Why did you come up with the bucket approach?
Evenski: Two reasons: withdrawing money at the wrong time was problematic; and when investors see their portfolios deflated, they panic and sell out. By having a cash reserve that they know where their grocery money comes from, they can hold out while everyone else jumps off the cliff.
Why is withdrawing money at the wrong time problematic?
If you take out money in a bear market, you are likely to sell stocks, which is probably not the right time to sell stocks. That’s when you want to buy. You want to buy low and sell high, which is the opposite of what most people do.
How does the cash bucket prevent that?
With the cash bucket, you are not forced to sell your long-term investments. You have control over when to sell them because you take the living expenses money out of the cash box.
When do you refill the bucket?
Because you monitor your investment portfolio in different periods, you need to rebalance the balance. That’s when you refill the money bucket. Or if the market has had a big run and you’re going to sell some stocks to buy bonds, you take a portion of that proceeds and fill the coffers again.
What happens during a prolonged crappy market?
Then you would have to sell bonds to buy stocks, so you take the opportunity to rebalance some of the bond sales and refill the coffers.
How often does this happen?
It has never happened again since we started using it in the 1980s. There has always been an opportunity to fill the money bucket with rebalancing. But if it did, you would dive into your investment portfolio and sell the short end of your bond duration portfolio where there would be little or no losses.
Some market experts don’t like the money bucket.
Certainly many articles have appeared about the inefficiency of the money bucket. And I can’t disagree with the pure math. If you set up a cash bucket, there are opportunity costs because that money isn’t in long-term investments. And that’s where I believe the behavioral aspects far outweigh any drawbacks.
Did you know that the money bucket would have a calming effect on investors when you started using it in 1985?
I don’t think I realized how powerful the effect would be. Go back to the crash of 1987. That seemed like the world had ended. That was really scary.
One thing I did was get on the phone and start calling customers. Nobody was happy. But nobody panicked and nobody called and said, ‘Harold, I can’t stand it. Take me to the register.’
How does your system work?
My goal was simplicity and something that made sense for the customers and something that they could easily live and manage. The only change over time was that the cash bucket originally had two years of additional cash flow. A few years later we made an academic analysis of it and came to the conclusion that one year was optimal. That reduced that opportunity cost of having more money in cash.
What do you mean by extra cash flow?
You don’t have to set aside 100% of your annual expenses. Only those expenses that would not be covered by a pension, Social Security, and so on. It’s a much smaller number than your annual expenses.
Some people put up to 10 years’ worth of cash and bonds in buckets. Is that a mistake?
I’m biased, but the answer is yes. It can feel good in the short term because people feel like, ‘Wow. I’m super protected.’ But unless someone is very wealthy, they can’t afford that size of opportunity cost.
Not only that, but the simple approach has worked extremely well. It worked during the crash of ’87. It worked during the technology stock crash, it worked during the great recession. The proof is the pudding.
Do you use a bucket approach yourself when investing your money?
It’s not that I probably need it. It’s the idea of eating up your own cooking. This is what we tell customers to do, and I think it’s what we should do.
How is your money invested?
My wife and I probably have 70% fixed income and 30% stocks. It’s changed significantly since I’m retired and over the years I’ve been lucky enough to accumulate significant assets. The asset allocation is a function of what I need to achieve my goals.
Do you think the stock market is ready for a decline?
The answer is yes, but that’s what it’s been telling me for years and it doesn’t affect our investment philosophy. I’m not a big believer in market timing.
You are trained as an engineer. How did you end up becoming a financial advisor?
A bit of a strange route. After the military, I joined my family’s construction company in Florida, and after a few years I started my own housing company. I loved what I was doing, but there was no future in it because of high inflation and mortgage rates going through the roof when home buyers could even get financing. I got a job as a stockbroker.
I really wasn’t unhappy with the brokerage, but they never understood what I wanted to do.
What did you want to do?
I wanted to do financial planning, not just sell investments. Every morning the manager would come in with a list of clients and how much they had in the money markets and he would say, ‘This client has a lot of money. There are some really good bond purchases out there. Why don’t you call them?’
And I’d say, ‘I know what they need. They don’t need any of this.’
Studies have shown that retirees spend less as they get older. You disagree.
The problem is, those surveys don’t indicate whether they’re spending less because they want to spend less or because they need to spend less. That’s a big difference.
Obviously, people with limited resources are likely to spend less because they need to spend less. But for those investors who have the means, when someone retires, the most important change is that they now have time to spare. Time costs money. Join the country club. Go take those cruises with your kids around the world.
I think the general conclusion that they spend less is nonsense.
So, as a wealth advisor, you had planned for clients to make the same expenses when they retire?
Yes. When we make plans, it is based on goals from year to year. Some years it can be a lot more because they want to take the world cruise they have always dreamed of, and the next year they may not travel. But I think it’s wrong to arbitrarily assume they’re going to spend less.
You have a pretty conservative approach. It means that many people should save more while working.
I agree with all of that except for the word conservative. I think it’s intelligent.
There is nothing unconservative about living in a dream world.
Is there anything else I should have asked you?
Hundreds of articles have been published about a person’s risk tolerance. And I finally came to the conclusion that the only rational definition of risk tolerance is the pain threshold, just before a client calls me up and says, “Harold, I can’t take it. Take me to the register.’
If you’re making decisions about the balance of your stocks and bonds, you can only be reasonably confident that you’ll be able to live with it when all hell breaks loose. And worse, when all hell breaks loose, you’d better do the opposite of what everyone normally wants to do. You have to sell what goes well and buy what goes bad.
When did you have to do that?
The most painful period I went through was the great recession. We are big proponents of rebalancing. Well, the market went down and we said, ‘Okay, we need to sell bonds and buy stocks.’ And everyone said, “Okay, sure.”
And then it went down again. And we said, ‘You know we gotta do it again,’
And they said, ‘Well, are you sure? The market just seems to be in free fall.’ And we said, ‘Yeah, that’s exactly what we need to do.’
And then it went down again, so we rebalanced three times. That was hard.
Everyone went along with it, not happy. But in hindsight, it certainly worked.
As we say to people, ‘Look. If the market continues to fall forever, all bets are off and it doesn’t matter what you’ve done. We’re all going to hell together.’ We’re not planning Armageddon. We have a fundamental belief that over time the domestic and global economies will rise, along with the investment markets.
Thank you, Harold.
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