Texas markets

Cash buckets make a living as markets slide. Don’t hold too much.

Financial adviser Harold Evensky pioneered the cash bucket strategy in 1985 so that clients would remain calm during market downturns and not be forced to sell depleted stocks to fund withdrawals. He first told customers to keep two years of extra living expenses in the cash bucket, but then reduced that to just one year.

Evensky, now 79 years old and retired from planning, disagrees with how the bucket approach is often used today. Some advisers keep up to 10 years of living expenses in short- and medium-term tranches, and long-term investments in a third tranche. Evensky prefers its simpler two-compartment 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 than that depresses returns.

Evensky, who has a degree in civil engineering and taught personal finance for years at Texas Tech University in Lubbock, Texas, also clashes with some common misconceptions about personal finance. For starters, Evensky disagrees with the idea that people naturally spend less after retirement; he says they spend less mainly because they have less. If they saved more while working, they would spend more in retirement, he says.

We joined him at his home in Lubbock. His answers have been edited.

Barron’s Retirement: Why did you come up with the bucket approach?

Evensky: Two reasons: withdrawing money at the wrong time was problematic; and when investors see their portfolios plummeting, they tend to panic and sell. By having a cash reserve that they know where their grocery money is coming from, they can hold on while everyone jumps off the cliff.

Why is withdrawing money at the wrong time problematic?

If you withdraw money in a bear market, you are probably selling stocks, which is probably not a good time to sell stocks. This is 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 money bucket avoid this?

With the cash bucket, you don’t have to sell any of your long-term investments. You have control over when to sell them, as you withdraw the funds for living expenses from cash.

When do you fill the bucket?

When you monitor your investment portfolio at different times, you need to rebalance. This is when you fill the bucket with money. Or if the market has risen sharply and you are going to sell stocks to buy bonds, you take some of those commodities and refill the basket with cash.

What happens during an extended lousy market?

Then you would have to sell bonds to buy stocks, so you take the opportunity while you rebalance to take some of the bond sales and refill the basket with cash.

How often does this happen?

This has never happened since we started using it in the 1980s. It has always been possible to fill the rebalance cash bucket. But if that happened, you would dip into your investment portfolio and sell the short end of your bond duration portfolio where there would be little or no losses.

Some market pundits don’t like the cash bucket.

There have certainly been many articles about the inefficiency of the fund. And I can’t disagree with pure math. If you set up a cash reserve, there is an opportunity cost because this cash is not invested in long-term investments. And this is where I think the behavioral aspects far outweigh the potential downsides.

Did you realize that the cash 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. Let’s go back to the crash of 1987. It seemed like the world had come to an end. It was really scary.

One thing I did was phone and start calling clients. No one was happy. But no one panicked, and no one called to say, ‘Harold, I can’t stand this. Take me to the money.

How does your system work?

My goal was simplicity and something that made sense to customers and something they could experience and manage easily. The only change over time was that the cash basket originally had two years of additional cash flow. A few years later, we did a theoretical analysis of it and concluded that one year was optimal. This reduced the opportunity cost of having more cash.

What do you mean by additional cash?

You don’t need to set aside 100% of your annual expenses. Only expenses that would not be covered by a pension, social security, etc. This is a much smaller number than your annual expenses.

Some people put up to 10 years worth of cash and bonds in buckets. Is it a mistake ?

I have prejudices but the answer is yes. It can be good in the short term because people feel “Wow”. I am super protected. But unless someone is very rich, he cannot afford such an opportunity cost.

Not only that, but the simple approach worked extraordinarily well. It worked during the crash of 1987. It worked during the tech stock crisis, it worked during the Great Recession. The proof is in the pudding.

Do you yourself use a bucket approach to investing your money?

Absolutely.

Why?

It’s not that I probably need it. It’s the idea of ​​eating your own kitchen. That’s what we tell customers to do, and I think that’s what we should be doing.

How is your money invested?

My wife and I are probably 70% fixed income and 30% equities. This has changed a lot because I am retired and over the years I have been lucky enough to accumulate significant assets. Asset allocation is based on what I need to achieve my goals.

Do you think the stock market is about to drop?

The answer is yes, but I’ve been told that for years, and it doesn’t influence our investment philosophy. I’m not a big fan of market timing.

You have been trained as an engineer. How did you become a financial advisor?

A kind of particular route. After the army I joined my family’s construction business in Florida and after a few years started my own home building business. I loved what I was doing, but there was no future due to high inflation and skyrocketing mortgage rates while homebuyers could even get financing. I got a job as a stockbroker.

I really wasn’t unhappy with the brokerage, but they never figured out 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 very good bond buybacks. Why don’t you call them?

And I would say, ‘I know what they need. They don’t need all that.

Studies have shown that retirees spend less as they age. You do not agree.

The problem is that these studies do not indicate whether they are spending less because they want to spend less or because they have to spend less. It’s a big difference.

Obviously, for those with limited resources, they probably spend less because they have to spend less. But for investors who have resources, when someone retires, the main change is that they now have free time. Time costs money. Join the country club. Go on a cruise with your children around the world.

I think the general conclusion that they spend less is nonsense.

So as a wealth advisor, you expected clients to have the same expenses in retirement?

Yeah. When we do planning, we base ourselves on annual objectives. Some years it may be a lot more because they want to take the world cruise they’ve 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 fairly conservative approach. This means that many people should save more while working.

I agree with all of this, except for the word conservative. I think that’s smart.

There’s nothing anti-conservative about living in a dream world.

Should I have asked you something else?

There have been hundreds of articles about a person’s risk tolerance. And I finally concluded that the only rational definition of risk tolerance is what that pain threshold is right before a client calls me and says, “Harold, I can’t take this.” Take me to the money.

If you’re making decisions about your stock-bond balance, you better be reasonably confident that when all hell breaks loose, you can live with it. And even worse, when all hell breaks loose, you better be prepared to do the opposite of what everyone wants to do. You have to sell what works well and buy what works badly.

When did you have to do this?

The most painful time I went through was the Great Recession. We strongly believe in rebalancing. Well, the market fell and we were like, “OK, we need to sell bonds and buy stocks.” And everybody said, ‘OK, of course.’

And then it fell. And we said, ‘You know we gotta do it again’

And they said, ‘Well, are you sure? The market seems to be in freefall. And we said, ‘Yes, that’s exactly what we have to do.’

And then it went down again, so we rebalanced three times. It was hard.

Everyone followed him?

Everyone accepted, not with pleasure. But in hindsight, it certainly worked.

As we tell people, ‘Look. If the market continues to fall forever, all bets are off and it doesn’t matter what you did. We will all go to hell together. We are not planning Armageddon. We fundamentally believe that over time, national and global economies will grow, and so will investment markets.

Thanks Harold.

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