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I friend of mine was talking about the bucket theory of portfolio management and asked me what I thought.

I never really studied the “bucket theory”.

Basically you own 3 buckets of money, risk free assets like T-bills, with 3-5 years of expected need, 5-15 years of moderate risk assets and 15+ years of risky assets or something like that.

My greatest investing discovery was the portfolio aggregator.

A portfolio aggregator allows one to look at the portfolio as a whole.

I use a custom aggregator but a common one is Personal Capital.

I have about 12 investing accounts of various tax consequences between my wife and myself, Roth, pre-tax IRA, post tax brokerage, banking and credit card.

I did have a mortgage (leveraged account) at one time as well.

I also use an aggregator called MINT to coalesce all of my expenses across various accounts.

 

I also have a documentation of my ongoing tax losses I have filed over the decades with the IRS.

 

I consider this a separate asset class, because the write off provides me with tax free money.

What that means is if I sell $10,000 of stock with a $3,000 cap gain instead of paying taxes I pay some capital loss from my cap loss statement and pay no tax.

I collect tax losses when the market goes underwater by using a technique called tax loss harvesting.

The reason I find the aggregator so powerful is I can synthesize my entire portfolio into a single asset with a single risk and a single return, and I know how all the moving parts are related to each other in terms non correlated diversity which is part of my risk management strategy.

In Personal Capital for example my portfolio exhibits a return of 8.1% and a risk of 10.2%.

My portfolio is on the efficient frontier and my asset allocations are tuned for most return vs least risk.

 

 

A full stock portfolio of S&P 500 (SPY) would have a return of 10.6% and 14.33% risk.

I like to keep my portfolio risk at about 2/3 of the SPY.

I also like the asset allocations to push me onto the efficient frontier.

A portfolio on the efficient frontier has the best efficiency on a risk adjusted basis.

The problem I see with the bucket theory is you are constantly spending up your risk:

• If your portfolio with 16% cash has a risk of say 10%, as you spend the cash the risk may go up to 12% or a 20% increase in risk which I would find unacceptable.

 

The way I manage is with what I call the epoch theory.

 

 

I divide my portfolio build up and draw down into periods of time that are consistent with life events.

I look at a building a retirement portfolio as if I’m purchasing a product.

What you are purchasing is future security, and you are trading your human capital (money gained from time spent in work) plus compounding (time money is spent growing) into a product meant to sustain you when you no longer work.

 

 

The product will still continue to compound likely at a lower rate as you siphon off funds to live on.

This is all stuff you know but presenting it like this is a little different because people tend to confuse their retirement portfolio with net worth.

In my calculation they are related but not identical.

During my working life I am putting money into my retirement portfolio.

I am also putting money into other “products”, like funding college, like buying cars and a house etc.

These may be part of my net worth but they are not part of my retirement portfolio.

Looking at my conception of a retirement portfolio therefore does not fit a bunch of buckets.

My daughter just recently graduated from college.

 

 

I saved for her education by purchasing a college product in what I call the college epoch.

I bought her a FL college education for $22,500 in 1998.

That education meant I had 120 credit hours of education available at any FL college from UF to a community college including fees.

This way a college education was assured even if I met the widow maker.

The price was fixed and paid in full so tuition inflation doesn’t enter in.

I also put $20K in a UGTM all in stocks and let it grow.

Over the course of 20 years it grew to about $70K.

I used that money to pay for most of her expenses including summer abroad and a trip touring Italy with her choir group and a car at the end.

She graduated debt free, cum laude.

She had 4 excellent years plus a car and it cost me 42K (28K was interest).

College didn’t enter into my retirement cash flow.

I call that my college epoch.

I did an analysis on future tax burden and RMD and decided I needed to Roth convert essentially all of my pre-tax to Roth.

 

 

The most efficient conversion for married filing jointly is to the top of the 24% bracket, so I invested to cover the Roth conversion epoch.

It consists of money to live on plus tax money to pay for the conversion.

I decided I would need about 4-5 years to convert, so I cashed out some post tax stock and mixed it with some cap loss to raise money to live on plus money to pay the taxes.

I backdated my conversion so I it would complete when I turn 70 just before RMD.

Since I’m living on cash, I’m earning 8% on my social security by letting it ride till 70.

Since I’m not taking social security I’m saving on the taxes social security would generate, allowing for maximally efficient Roth conversion.

I call this the Roth conversion epoch.

At 70 I will re-evaluate my social security income added to my needs and start the social security epoch.

About 5 years later my wife will reach social security age and that will become the dual social security epoch.

 

 

Four years after that she will reach 70 and if there is any RMD left in her accounts we will start dual SS + RMD epoch.

So that’s my method, the epoch method.

Each epoch is tailored for best tax efficiency and adequate funding.

Through out it all I rebalance the portfolio and keep my risk and return constant.

 

 

Depending on how it looks at 70, I may create a portfolio insurance account which is a separate amount of money in a risk free asset enough for 2x annual withdrawal rate.

This would give me money to live on just in case of a really bad market so I don’t have to sell shares when stocks are down and I can rebalance the portfolio without selling shares to live on.

Two years worth of annual withdrawal amount can become 3 years of living or possibly even 4 with some belt tightening.

So that insurance account does constitute a kind of bucket.

So far the plan is working out nicely, I have a comfortable life and more money than the day I retired despite living expenses.