A year-end to-do list for bucket investors

Bucket maintenance can also get complicated. That’s in part because there may be multiple accounts in the mix but also because the right assets to tap for cash needs in a given year depend on the year. In a very strong equity market like 2019, trimming appreciated equity assets will be the ticket to raise cash in most instances. In weak years like 2018, most retirees will be better off leaving stocks alone and instead pulling from safe assets to fund living expenses.

If you’re employing a bucket strategy, here are the key items to have on your docket as 2019 winds down.

Step 1: Check this year’s spending rate
Buckets or not, a key item for retirees as they review their portfolios and their plans should be to take a look at spending over the past year. Have actual portfolio withdrawals been in line with your withdrawal amount targets? It’s easy to get comfy with a bit of extra spending amid the very strong market environment that has prevailed for most of 2019. The “wealth effect” is alive and well, and most of the research on retirement withdrawals suggests that retirees should be able to spend more in strong markets, provided they can pull in their belts and spend less in weak ones. To help gauge your spending rate, total up all of your portfolio withdrawals for 2019, then divide them by your portfolio balance. Does it pass the sniff test of sustainability?

Step 2: Assess cash needs for the year(s) ahead
The next step as you refresh your buckets for 2020 is to forecast your cash flow needs for next year. In addition to the funds you need for your routine living expenses, are you expecting to make any out-of-the-ordinary outlays next year, such as a new car, major trip, or home repair/upgrade? Armed with an all-in budget for the year ahead, you can then look at how much of your total outlays will be met through non-portfolio-income sources--Social Security, a pension, a fixed annuity, and so forth. Subtract those income sources from your total planned spending to arrive at your planned portfolio withdrawal, and check its sustainability. Document your portfolio spending need; we’ll come back to that number in a moment. If your Bucket strategy entails holding two years’ worth of portfolio withdrawals in cash--and I think that’s advisable because it can provide a bit of a buffer in weak markets--forecast your cash flow needs for 2020 and 2021.

Step 3: Size up Bucket 1
Once you’ve arrived at your cash needs for the year(s) ahead, compare that with your current liquid reserves on hand. If you’ve been steering dividends and bond income back into your cash bucket over the past year (part of a “hybrid” strategy for bucket maintenance), you have extra cash because you have recently taken required minimum distributions, or you have cash left over for any other reason, you’ve probably filled up your cash bucket at least partially and will need to lean less on rebalancing for the job. Subtract current cash reserves from the cash needs you arrived at in Step 2; the amount left over is the additional amount you’ll need to extract from your portfolio from rebalancing.

Step 4: Assess long-term asset allocation
Next, take a look at your long-term portfolio using Morningstar’s X-Ray functionality, which depicts your actual asset-class exposures based on the composition of your holdings. Take note of your portfolio’s current allocation relative to your asset-allocation target as laid out in your investment policy statement. If you have a healthy complement of stocks in your portfolio, it’s likely that portion has appreciated nicely over the past year and is taking up a larger share of your total portfolio than you intended it to.

Step 5: Source cash for Bucket 1
Identifying overweighted positions in your portfolio will point you toward those areas that you can trim if you need to top up your Bucket 1/cash holdings, as discussed above. For most investors as 2019 winds down, selling appreciated equity holdings, especially large-cap growth stocks and funds, is a logical place to start if they need to raise cash. Specifically which equity holdings you sell to raise cash will depend on what sequence of portfolio withdrawals you’re using for your accounts. If you’re subject to required minimum distributions and haven’t yet taken your RMD, you’ll obviously want to concentrate your selling within your RMD-subject tax-deferred accounts.

Step 6: Identify additional rebalancing needs 
Pulling your cash needs from appreciated holdings may be sufficient to restore your baseline asset-class exposures back to your targets. However, it’s a good bet that additional rebalancing may be in order, especially because 2019 has been such a huge year for U.S. equity investors. Other asset classes, such as bonds and foreign stocks, have done quite well, too, but not as well; growth strategies have continued to trump value.

Unless you’re employing a static or conservative-trending glide path for your in-retirement asset allocation, you may not need to top up your bond holdings; bonds have held their own. But your intra-equity positioning could very likely use some tweaking. Valuation-conscious investors may want to peel back U.S. equity exposure and steer the proceeds into foreign stocks; ditto for trimming growth in favor of value.

Step 7: Tie in charitable giving 
Last but not least, if you're charitably inclined, it may make sense to tie in charitable gifts with the steps outlined above. For example, if you're an RMD-subject investor and need to rebalance your portfolio, you might want to direct a portion of your rebalancing proceeds to charity via a qualified charitable distribution. That has the salutary effect of lowering your adjusted gross income. Alternatively, if your rebalancing plan involves taxable accounts, you might consider taking advantage of 2019's outsize gains to make a larger-than-usual contribution to charity. With higher standard deductions in force today, the strategy of "bunching" charitable contributions in order to exceed the standard deduction threshold makes more sense than ever.