If there’s one fundamental takeaway from the research on safe withdrawal rates, it’s that market volatility really matters during a retiree’s withdrawal years. Even when long-term returns average out in the end, if the sequence of volatile returns is unfavorable, there is a danger that ongoing distributions during the bad years early on could deplete the portfolio before the good years ever come.

As a result, many advisors and their clients use strategies that avoid taking distributions from asset classes such as equities during down years. One example is setting aside buckets as a reserve against market crashes. Or you might create a series of “decision rules” that state outright that equities will be sold only if they’re up; otherwise, bonds will be liquidated instead, with cash/Treasury bills to be used if everything else is in the red at once.

Yet when such bucketing or decision-rules strategies are paired with simple rebalancing, it turns out the outcome is no better than merely managing the portfolio on a total-return basis alone. The key, it turns out, is that simple rebalancing already has an astonishingly powerful effect in helping to avoid unfavorable liquidations, as the process systematically ensures that the investments that are up (the most) are sold, and the ones that are down (the most) are held and, in fact, bought instead.

This means advisors may not be giving rebalancing alone nearly the credit it deserves to accomplish similar — or even better — results than setting aside buckets and creating decision rules. The buckets and decision-rule approaches are perhaps better purposed as explanatory tools for clients, rather than as actual systems for generating cash flows in retirement.


To avoid the danger of selling equities (or any other asset class) after a loss, one of the most popular solutions is simply to establish a series of rules dictating that equities will not be sold in such circumstances, and then to manage assets in a series of buckets.

For instance, an advisor separates a retiree client‘s portfolio into three buckets: No. 1 holds equities (e.g., the S&P 500) and accounts for 60% of the portfolio; No. 2 is invested in intermediate government bonds for 30% of the portfolio; and No. 3 holds the last 10% in cash (i.e., Treasury bills). Once these three buckets are established, the retiree might use the following decision-rule framework for liquidations:

  1. If equities are up, take the retirement spending from equities.
  2. If equities are down but bonds are up, take the spending from bonds instead.
  3. If both equities and bonds are down in the same year, take the distribution from Treasury bills.

Using this decision-rules approach, the “Bucket Liquidation Strategy” chart below shows the retiree’s results if retirement began in 1966, assuming a 4% initial withdrawal rate and distributions adjusted each subsequent year for inflation. Liquidations occur at the end of each year, and the portfolio is rebalanced back to its original 60/30/10 allocation at the start of each year. (Transaction costs are assumed to be negligible, and taxes are not included.)
A deeper look at the year-to-year returns shows that, in fact, the liquidations really did have to come from varying asset-class buckets over time in order to avoid selling after a decline. The lower part of that chart shows the source of liquidations from year to year.

Given that, for most of that time, equities had positive returns, in 23 years the distribution came from stocks. However, in six years it came from bonds, and in one year (1969) the distribution came from Treasury bills as both stocks and bonds were down that year.

Thus, as the outcomes highlight, the retiree could avoid taking distributions from investments that have declined. The approach allowed the retiree to effectively preserve principal at a 4% initial withdrawal rate, even through a difficult time period (leaving nearly all the principal at the end to boot).


For many advisors, the goal is to manage a portfolio holistically on a total-return basis, which is not necessarily consistent with a bucket-based liquidation strategy using decision rules. With a total-return approach, portfolios are often still rebalanced systematically to keep them on target (which will trigger some sales and purchases). However, there is no overt strategy in place to avoid taking retirement income distributions from asset classes that were down in the prior year while only generating distributions from investments that were up.

Nonetheless, we can evaluate the effectiveness of taking systematic withdrawals from a total-return portfolio that is rebalanced annually. The “Rebalancing Strategy Alone” chart below shows the retiree’s results if retirement begins in 1966, assuming a 4% initial withdrawal rate and distributions that are arbitrarily taken pro rata (60/30/10) from each asset class at the end of every year. The portfolio is rebalanced back to its original 60/30/10 allocation at the start of each year. Again, transaction costs are assumed to be negligible, taxes not included.

As you can see when looking at both charts, the rebalancing results appear quite similar to the decision-rules strategy. In fact, the decision-rules strategy coincides precisely with the total-return rebalancing strategy. The results are not just similar; they are exactly the same. The aforementioned decision-rules bucket approach has no impact over the total-return rebalancing approach.

To understand why the decision-rules-based buckets liquidation strategy and the total-return rebalancing strategy were the same in the above example, remember those assumptions used for the decision-rules framework.

Once a portfolio is already going to be rebalanced every year, the impact of decision rules is made null and void, and the buckets are essentially just an asset-allocation mirage. This is because the total amount of withdrawals is always the same, regardless of which asset classes they are taken from, and the final allocation is also always the same, due to the rebalancing.

For example, a portfolio that starts out with $1 million in 1966 — one of the worst years of the past century to begin retirement — would finish the year at $958,443.80, due to a fairly significant equity loss that is only partially offset by gains in bonds and bills. And because a $40,000 withdrawal must occur (from some asset class or another), the ending balance after withdrawals is going to be $918,443.80.


That means that no matter where the withdrawal is taken from, the asset-class allocations will ultimately be rebalanced back to 60/30/10, which means $551,066.28 in equities, $275,533.14 in bonds and $91,844.38 in bills. Changing which pre-rebalancing asset classes generate the distribution could impact the (assumed-to-be-negligible) transaction costs, but it doesn’t change the account balance ($958,443.80) right before liquidation, nor does it change the 60/30/10 allocations of the remaining $918,443.80 right after the liquidation and entering the following year.

What is also notable about this rebalancing result is that the investor will not only avoid selling equities, but will actually be selling bonds and bills to buy equities. In other words, the decision rules are not necessary to ensure that equities are not sold when they are down; in fact, rebalancing alone not only ensures that result, but also leads to the purchase of even more equities when they have lost value, in order to benefit from a likely future rebound.

The “How Rebalancing Helps” chart below shows the results of just using the decision-rules approach without rebalancing along the way. As the results reveal, this strategy is worse — so much worse that the portfolio hardly has anything left at the end. The outcome is much better with rebalancing, because under that approach, the client doesn’t just avoid selling stocks when they’re down, but actually buys equities during dips.

Not only are decision rules irrelevant once the portfolio is regularly rebalanced, but eliminating rebalancing is so damaging that decision rules alone lead to a worse outcome.

The reason that not rebalancing fares so much worse is that, in an adverse scenario such as this — especially with an equity decline from the start — the ongoing inflation-adjusted withdrawals become so significant that they eventually overwhelm the equity portfolio. That’s especially true when there are not any additional purchases of equities after they decline (even if there are no sales until equities start to bounce back).

Without rebalancing back into equities after market declines, the inflation-compounding impact of the withdrawals eventually depletes the equity exposure altogether. Once equities are gone, the remainder of the portfolio — now entirely in fixed income — struggles to keep up.


What does all of this mean for planners trying to help navigate sequence-of-return risk for their retired clients?

The first key point is simply to recognize the awesome impact of rebalancing itself. While classically viewed as a mechanism to just “keep the portfolio on target with its allocations,” the reality is that rebalancing alone is effectively a powerful liquidation tool as well; it ensures that only the investments that are up (the most) are sold while the investments that are down (the most) are bought.

The second key point is to recognize that decision-rules strategies liquidating from various buckets may be insufficient to sustain retirement. This is not because they’re ensuring equities don’t get sold when they’re down, but because they fail to buy more when equities have lost value. In other words, the bond and cash buckets need to do more than just generate retirement distributions when equities are down. They also need to be deployed to proactively buy more equities when they’re down — which occurs automatically with rebalancing, but not with buckets alone.

Rebalancing is an indirect methodology that ensures that the retiree “sells high and buys low” to enhance long-term returns. (This is also why a systematically rebalanced portfolio is a better means to implement a rising-equity glidepath than just a buckets-based liquidation strategy.)

Advisors should not underestimate the incredible impact rebalancing has on a portfolio, “automatically” ensuring that liquidations come from investments/asset classes that are up, and also creating a process that allows the retiree to buy even more of an asset class when it is down. And of course, the more (not perfectly correlated) asset classes the retiree holds, the greater the opportunity for rebalancing to exert its favorable effects — i.e., the outcomes may be even better in practice than the three asset-class example here.

Meanwhile, be cautious about decision-rule bucket strategies that can actually go so far as to adversely distort the portfolio in a manner that leads to worse outcomes — by leading to an excess cash position, for instance, or by failing to buy more equities after a decline and allowing equities to be depleted too rapidly during a bad return sequence.

Ultimately, the point of this discussion is not to make the case that decision-rules bucketing strategies are inferior. To the contrary, as long as they are implemented along with rebalancing, their results are exactly the same.

And if clients are more comfortable with bucketing strategies — if only because they appeal more naturally to people’s tendency toward mental accounting — then so much the better. Just be certain to recognize that, while it may be more effective to explain portfolios as a series of buckets to clients, you should be sure not to allow the asset allocation to become distorted by trying to actually manage the portfolio too strictly in such a manner.

Michael Kitces, CFP, a Financial Planning contributing writer, is a partner and director of research at Pinnacle Advisory Group in Columbia, Md., and publisher of the planning industry blog Nerd’s Eye View. Follow him on Twitter at @MichaelKitces.

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