Exchange traded funds have yet to break into a 401(k) retirement platform, but there are still ways to incorporate these tools into such a plan. A shorter-term “bucket” portfolio, with a time frame of about 15 years, is the latest method that Morningstar highlights, which gives exposure to equities, bonds, cash, and other assets for conservative investors.
“The biggest benefit of a portfolio anchored in broad-market ETFs or index funds is the ability to be hands-off. With a few small tweaks every once in a while, such a portfolio could virtually run itself for a while if need be. Given that most retirees have better things to do with their time than toil over their portfolios, that’s a valuable attribute indeed,” Christine Benz wrote for Morningstar. [A Guide to Target-Date ETFs]
“Buckets” are a way to segment a portfolio for a specific time frame, which can support a retiree’s goal and mindset. The idea is to visualize the way one would want their portfolio to look like and should focus on when the investor would want to be in cash, reports Benz. The shorter-term bucket portfolio consists of 30% equities, 60% bonds and other, and 10% cash. Specific dollar amounts are not permanent and investors can adjust amounts to cater to larger or smaller portfolios. Model bucket portfolios can be viewed on the Morningstar article.
“Under the framework I’ve been using, money for near-term income needs gets parked in bucket 1. Bucket 2 houses intermediate-term assets–typically bonds–while bucket 3 is the longest-term portion of the portfolio and consists mainly of equities. The shorter the investor’s time horizon, the higher the percentage of total portfolio assets that will be parked in buckets 1 and 2. As bucket 1 is depleted, it gets refilled with assets from buckets 2 and 3,” Benz wrote.
The difference of the “bucket” approach versus an income only approach is that the investor does not have to dip into riskier securities to gain yield, as the higher quality stocks and bonds have a low-yield at this time. The result is better diversification and a better risk/reward profile, which is essential to a retiree, who needs to preserve as much capital as possible. [ETFs Have Room for Growth in Retirement Plans]
If an investor chooses low-cost, broad-based ETFs to comprise their bucket portfolio for retirement, costs will be kept low. Since the approach is generally hands-off, trading costs are kept to a minimum and the drag of taxes wont be as harsh. [A Bucket ETF Retirement Strategy for Moderate Investors]
Tisha Guerrero contributed to this article.