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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.
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The epoch theory. This is an awesome idea. Drawing down from your portfolio that is consistent with periods of time relating to life events makes a lot of sense, especially with respect to tax minimization and efficiency. It’s something everyone should consider.
Does the Roth conversion epoch strategy change for someone who is expecting a decent (200k /yr ) retirement pension? If that was the case for me, I imagine I wouldn’t be able to minimize taxes as efficiently.
Hey DMF, thanks for the comment and yeah I think Gasem has another home run of a post. That is definitely a great problem to have with a $200k/yr pension in retirement. That will certainly have you pushing into the upper echelons of tax brackets for sure. Depending on future tax brackets you will likely have room to maneuver some but you will lose the lower tax bracket advantages when it comes to capital gains (where in the lowest tax brackets you can actually get away with no capital gains at all). I would advise for you to do some… Read more »
Thanks! I’ll definitely do some more research on it!
Conversion is a process of optimization and optimization is sometimes a “do as good as you can do” proposition. In my analysis Roth conversion is a trade off between length of time converting and per year cost of conversion and total cost of conversion, and some means to amortize the cost of conversion (break even) with the possible future gains. In my case with a 4 or 5 year conversion, I realize an additional $750K on my end portfolio value at 30 years compared to letting the government bleed me to death at current rates under RMD. The real kicker… Read more »
Thanks for the thorough response, Gasem. When the time comes, I’ll definitely do a Roth conversion analysis to see how I can best optimize my tax situation. I am hoping to accumulate a lot of Roth money by the time we retire through my and my wife’s back door Roth IRA’s and our Roth 401k’s. It’s so great to have your perspective as some one who has been there and done that with respect to conversion strategies, retirement, and draw down. I feel like asset accumulation, saving, and investing is simple and easy. But it’s the draw down and decummulation… Read more »
Accumulation is about getting rich. Deflation is about becoming poor again at a highly controlled rate. Entirely different processes with some similar characteristics (like compounding). The goal of deflation is to not die poor.
Dr McFrugal can you retire a few years before you get the $200k pension? If so you can Roth convert during those years and control your bracket.
Ah, that’s a good point Hatton! Yes, I think I can retire a few years prior to when I will receive a pension. That would be a perfect time to Roth convert! Thanks for the tip ?
Excellent post and a well-articulated, organized discussion of what many of us are organically doing in our own scattered minds. I like the “epochs” nomenclature, but personally, I like “regimes” for myself, even better.
I might personally explore the “regimes” of the physician career at some point.
Thanks VagabondMD for stopping by and commenting. Before I read this post I was on the bucket theory of retirement withdrawing strategies, but I do like how Gasem has made it a little more individualized with epochs. Regimes also sounds like a great way to look at it and definitely look forward to your views on regimes and physician careers if you do create a post out of it (and I know since you don’t have a blog of your own, I would definitely be honored if you would consider mine as a potential platform for your views on that… Read more »
My old surgery professor would read you out for using regime. He insisted on regimen, which is a good word for this practice. Regimes are governments, regimens are plans of action. It’s an interesting notion linking regimen and physician career especially if you include debt and time to get there, but looking in the rear view this was a great career choice. I did some commodities trading before medicine and many of those guys were all boom or bust, stressed to the max, divorced, and drug addicted. Some were wildly rich as well. I knew many who were not but… Read more »
Just like what Gasem said, I think of regimes as governments.
So is your “regime system” similar to Gasem’s “epoch system” but with different nomenclature? Can’t wait for you guest post on explaining exactly what it is!
Okay, now the pressure is on to deliver the goods!
Now that I see Gasem’s plan- we have a very similar plan. I have different strategies but the thinking is similar. I see some folks have anxieties because they are waiting for their financial advisor to tell them what they should spend. Or worse, they think some mammoth number alone will save them. I always plan with the end in mind. I always think about exit strategies and what the end goal of whatever I plan is. Just like my home. I never got in trouble with a doctor house because I buy my homes with a two or three… Read more »
You definitely have created a wonderful plan and have set yourself up for success for you and your kids. And simpler really is better especially as we age and lose track of all the different moving parts (plus it is easier for a heir to carry it on if straightforward). As always I enjoy your comments and insights.
You are my hero MB! A true study in parsimony (most benefit for least cost, risk adjusted over time). You my dear get an A+
Nice post… I will comment more later but I am having trouble since your mobile site has too many things going on like am sharing and email capture. I recommend trying to submit comments yourself to test it out. Otherwise great guest post!
Appreciate the feedback especially when commenting on a mobile platform. Will tinker around with it and hopefully reduce that annoyance.
I just went in the settings and made some changes for hopefully a better mobile experience. I completely removed the social sharing icons that were on the bottom (there are still embedded in the post itself so hopefully still easy to share on social media for everyone) and I made the email subscription request on the bottom of every type of device have the ability to “X” out of and close. I hope that makes commenting on mobile devices much easier. Again thank you for calling attention to this. Trying to make it a good user experience while at the… Read more »
Much better! Thanks for responding. Looks like there is still plenty of ways to socially share too.
Glad it is better 🙂 Thanks for letting me know first about the issue and then the follow up that those steps I took made a difference. As admin on this site I have a different look most of the time from what the end user sees, and because I do most of it on a desktop, the mobile platform was not on my radar to check for those issues you had. Thank you for making it a better experience for everyone and if there are any other things that crop up, feel free to let me know and hopefully… Read more »
Life is a series of epochs I suppose. I consider myself to be in the treading water epoch prior to the retirement/drawdown epoch. When one is treading water You no longer feel the need to save money just not draw down the pile too much. At least that is how I feel.
I like it. Treading water epoch. Other alternative nomenclature could be in limbo epoch or for the more morose, purgatory epoch
Limbo perhaps but not purgatory.
Very cool post, Love the way you describe the epoch theory.
Yeah Gasem has a great mind and perspective. I have certainly picked up a lot from him