Harold Evensky, at his home in Key West, Fla., says he’s “concluded that the only rational definition of risk tolerance is what is that threshold of pain right before a client calls me up and says, ‘Harold, I can’t stand it. Take me to cash.’ “
Photograph by Mary Beth Koeth
Financial advisor Harold Evensky pioneered the cash bucket strategy in 1985 so clients would stay calm during market downturns and wouldn’t be forced to sell depleted shares to fund withdrawals. He originally told clients to keep two years’ worth of supplemental living expenses in the cash bucket, but later cut that down to a single year’s worth.
Evensky, now 79 years old and retired from planning, disagrees with how the bucket approach is often used today. Some advisors keep up to 10 years’ worth of living expenses in short-term and intermediate-term buckets, and long-term investments in a third bucket. Evensky prefers his simpler two-bucket approach: one for cash, the other for long-term investments. He says a year’s worth of cash is plenty to protect investors from market volatility, and holding more than that drags down returns.
Evensky, who has a degree in civil engineering and taught personal finance for years at Texas Tech University in Lubbock, Texas, also pushes back against some of the conventional wisdom in personal finance. For starters, Evensky disagrees with the belief that people naturally spend less after they retire; 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 reached him at his home in Lubbock. His responses 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 tank, they tend to panic and sell out. By having a cash reserve that they know where their grocery money is coming from, they can hang on while everybody else is jumping off the cliff.
Why is withdrawing money at the wrong time problematic?
If you’re withdrawing money in a bear market, you’re likely selling equities, which is probably not the right time to be selling equities. That’s when you want to be buying. You want to buy low and sell high, which is the opposite of what most people do.
How does the cash bucket avert that?
With the cash bucket, you’re not forced into selling any of your long-term investments. You have control over when to sell them because you’re taking the funds for living expenses out of the cash bucket.
When do you refill the bucket?
As you monitor your investment portfolio at different periods, you need to rebalance. That’s the time you refill the cash bucket. Or if the market has had a big run-up, and you’re going to be selling some stocks to buy bonds, you take some of those proceeds and fill the cash bucket back up.
What happens during a prolonged crummy market?
Then you should be selling bonds to buy stocks, so you use the opportunity as you rebalance to take some of the bond sales and fill the cash bucket back up.
How often does this happen?
It has never happened since we started using it in the 1980s. There has always been an opportunity to refill the cash bucket from rebalancing. But if it did happen, then you would dip into your investment portfolio and sell off the short end of your bond-duration portfolio where there would be little or no losses.
Some market experts don’t like the cash bucket.
There have certainly been many papers on the inefficiency of the cash bucket. And I can’t disagree with the pure math. If you set up a cash bucket, there’s an opportunity cost because that cash isn’t in long-term investments. And that’s where I believe the behavioral aspects far outweigh any potential disadvantages.
Did you realize 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. Go back to the crash of 1987. That looked like the world had come to an end. That was really scary.
One thing I did was get on the phone and start calling clients. Nobody was happy. But nobody was panicked, and nobody called up and said, ‘Harold, I can’t stand it. Take me to cash.’
How does your system work?
My goal was simplicity and something that made sense for the clients and something they could live with and manage easily. The only change over time was the cash bucket originally had two years’ worth of supplemental cash flow. A number of years later we did an academic analysis of it, and concluded that one year was optimal. That reduced that opportunity cost of having more money in cash.
What do you mean by supplemental cash flow?
You do not need to set aside 100% of what your yearly expenses are. Only those expenses that would not be covered by a pension, Social Security, and so on. It is a much smaller number than your annual expenses.
Some people put up to 10 years’ worth of cash and bonds in buckets. Is that a mistake?
I’m prejudiced but the answer is yes. It may feel good in the short term because people feel, ‘Wow. I’m super-protected.’ But unless someone is very wealthy, they cannot afford that magnitude of opportunity cost.
Not only that but the simple approach has worked extraordinarily well. It worked during the ’87 crash. It worked during the tech-stock bust, it worked during the great recession. The proof is in the pudding.
Do you use a bucket approach yourself in investing your money?
Absolutely.
Why?
It’s not that I probably need it. It’s the idea of eating your own cooking. This is what we tell clients to do, and I think it’s what we should do.
How is your money invested?
My wife and I are probably 70% fixed income and 30% equities. It’s changed significantly because I’m retired and over the years I’ve been lucky to accumulate significant assets. The asset allocation is a function of what I need to achieve my goals.
Do you think the stock market is poised for a fall?
The answer is yes, but it’s been telling me that for years, and that does not influence our investment philosophy. I’m not a big believer in market timing.
You were trained as an engineer. How did you end up being a financial advisor?
Kind of a peculiar route. After the Army, I joined my family’s building business in Florida, and after a couple of years started my own home-building business. I loved what I was doing, but there was no future in it because of high inflation and mortgage rates going through the roof when home buyers could even get financing. I got a job as a stock broker.
I really wasn’t unhappy at the brokerage, but they never understood 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 money markets and he would say, ‘This client has a lot of money. There’s some really good bond buys out there. Why don’t you call them up?’
And I’d say, ‘I know what they need. They don’t need any of this.’
Studies have found that retirees spend less as they get older. You disagree.
The problem is those studies don’t indicate whether they are spending less because they want to spend less or because they have to spend less. That’s a big difference.
Clearly for those with limited resources, they are probably spending less because they have to spend less. But for those investors who have resources, when somebody is retired, the main change is they now have time on their hands. Time costs money. Join the country club. Go take those cruises with your kids around the world.
I think the general conclusion that they spend less is nonsense.
So as a wealth advisor, you planned on clients having the same spending in retirement?
Yeah. When we’re doing planning, it’s based on goals on a year-by-year basis. Some years it may be a lot more because they want to take the world cruise they’ve always dreamed about, and the next year, they may not be traveling. But I think it’s wrong to arbitrarily assume they’re going to be spending less.
You have a pretty conservative approach. It means a lot of people would have to save more while working.
I agree with all of that, except for the word conservative. I think it’s intelligent.
There’s nothing un-conservative about living in a dream world.
Anything else I should have asked you?
There have been hundreds of papers on someone’s risk tolerance. And I finally concluded that the only rational definition of risk tolerance is what is that threshold of pain right before a client calls me up and says, ‘Harold, I can’t stand it. Take me to cash.’
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 everybody typically wants to do. You need to sell what’s doing well, and buy what’s doing poorly.
When have you had to do that?
The most painful period that I went through was the great recession. We’re big believers in rebalancing. Well, the market went down and we said, ‘OK, we need to sell bonds and buy stocks.’ And everybody said, ‘OK, sure.’
And then it went down again. And we said, ‘You know we need to do it again,’
And they said, ‘Well, are you sure about that? The market just seems like it’s in free fall.’ And we said, ‘Yeah, that’s just what we got to do.’
And then it went down again, so we rebalanced three times. That was difficult.
Everybody went along with it?
Everybody went along with it, not happily. But in hindsight, it certainly worked.
As we tell people, ‘Look. If the market keeps going down forever, all bets are off, and it won’t matter what you’ve done. We’ll all be going to hell together.’ We don’t plan for Armageddon. We do have a basic belief that over time the domestic and world economies will go up, along with investment markets.
Thank you, Harold.
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