To Prepare or Position – The Bucket or The Barbell?

Written by Tom Stanley, Investment Adviser, May 2024



Summary:

  • As outlined in Morgan Housel’s quote above, the important parts of future are not easy to forecast – when you are walking into the unknown it is difficult to prepare for every possible outcome.
  • My suggestion: ‘position’ like a pessimist, ‘plan’ like an optimist.
  • What does this look like in practice? It depends on your stage of life and goals.
  • If you are currently saving and investing, or ‘accumulating’ assets working toward a goal, you are what we call an ‘accumulator’. If this is you, look at The ‘Barbell Strategy’ section below.
    • Positioning at this stage may look like two distinct allocations, one to ‘low-risk’ investments and on the other side of the ‘barbell’ ‘high-risk’ investments (and very little allocated to the ‘moderate’ middle).
    • Each investors perception of ‘high-risk’ may be different, but this framework is designed to allow for optimistic long-term plans, while protecting against ‘blow up’ risks in the short term.
  • If you are already retired or looking to draw on your assets soon, then you are likely what we call a ‘decumulator’ and should look at The ‘Bucket Plan’ section below.
    • Positioning at this stage may look like a series of deliberate ‘buckets’ where an investor aligns their investments with their expected spending/timeline.
  • This approach naturally leads to a diversified strategy where you don’t get caught up with ‘all of your eggs in one basket’ as discussed in ‘when being conservative can be high risk’.

Feel free to skip ahead to the section most relevant to you – we find the Barbell Strategy and the Bucket Plan helpful concepts for developing wealth and retirement plans.
 
Please don’t hesitate to reach out if you would like to discuss how either of these concepts can apply to your situation, at the bottom of this note are links to book calls with our advisers – we are here to help.  



To Prepare or Position – let’s dig in…

Investing is a journey, and often a painful one. It is very easy to get cute, and find yourself caught up in complexity – the issue? With complexity comes more decisions, more action, and often more opportunity to second guess yourself (and screw up).
 
I believe having simple frameworks that map what you are trying to achieve, with how you are investing, and why, help any investor navigate the uncertainties of the financial world.
 
In this note, we’ll explore high-level concepts about diversification (and concentration), examine some insightful quotes, and introduce two practical frameworks – the Barbell Strategy, and the Bucket Plan – to help you manage your investments effectively.
 
The inspiration for this month’s note came from a social media post from Shane Parrish of the Farnham Street Blog.

This tweet from Shane (another author I respect a lot), really stuck with me – while it appears very generic on the surface, it hits a point I have learned in my time in financial markets.
 
Financial markets can be humbling, very humbling.
 
The future is very difficult to predict, and in the face of that difficulty, you can either back yourself to be lucky (and ready to be humbled), or position yourself to make luck less relevant.
 
How does one make luck less relevant? In general, through thoughtful diversification – where one holds various asset classes (like you would in a traditional balanced fund).
 
The below chart from the team at Booster hammers home this point.

In this chart you can see NZ Shares were the best, if not second-best investment to hold from 2012 all the way until 2020.
 
Surely that 8 year run is enough reason to go all in on NZ shares right?
 
Well unfortunately, NZ Shares went from the best, to one of the worst places to be invested over the past 3 years.
 
The NZ Shares story is interesting (and one for another note), but the main point of the above chart is that the ‘Balanced Portfolio’ (which holds a blend of each asset class) is never ‘the best’ or ‘the worst’ during any time period – it may create some FOMO over time, but it represents textbook ‘positioning’ in the face of an uncertain future.  
 
Please note, I am not saying a ‘balanced’ portfolio is the answer to everything. We are all different and investment strategy clearly doesn’t have a one-size-fits-all solution – for example:
 

  • Investor 1: ‘Steve’ may have a longer time horizon for his investments, or Big Hairy Audacious Goals (BHAGs) that require higher returns than can be expected from a balanced portfolio.

 
or
 

  • Investor 2: ‘Staci’ may have a shorter investment time horizon and doesn’t have the tolerance or emotional state for swings between -9.7% one year to +12.1% the next year (or more as illustrated by the Balanced Portfolio above).

 
So, how do you (or Steve and Staci) ‘position’ for the future in a way that works for you?
 
Enter the Barbell Strategy & the Bucket Plan.



The Barbell Strategy (for Accumulators):


The concept of the Barbell Strategy is not original, the first reference I saw of the concept was as a trading strategy proposed by Nasim Taleb in his book, “Black Swan”.
 
In The Black Swan, Taleb proposed the idea of the “barbell portfolio” as a way to manage risk in investment strategies. The concept draws inspiration from the structure of a gym barbell, where most of the weight is concentrated at the two ends with an empty space in the middle.
 
In the context of investing, the “barbell portfolio” strategy involves dividing your investments into two distinct categories:

  1. Extremely safe assets or risk mitigators: These are investments and policies that are highly resilient to market volatility, economic downturns and life events. They typically include cash, short-term government bonds, insurance policies etc. The purpose of allocating to these safe assets or risk mitigators is to provide stability and preserve capital, especially during times of personal or market stress.
  2. Highly speculative, high-risk assets: On the other end of the spectrum, the barbell strategy involves allocating a portion of your portfolio to high-risk, high-reward investments. These might include direct business ownership, shares (via KiwiSaver, direct or via managed funds), leveraged investments, or alternative assets. The aim here is to potentially achieve outsized returns, capitalizing on opportunities for significant growth.

Note: Taleb’s version of this strategy (as a wall street trader) was much more extreme than I’ve outlined above. Allocations proposed to be up to 95% of assets to the ‘safe’ end of the barbell, with 5% to high-risk side of the barbell with extremely leveraged bets made via options – (I don’t suggest this appropriate for most, if any clients)

Morgan Housel (as usual) captured the essence of this approach best when he said:

“What I want to have is endurance. I want to be so unbreakable financially in the short run to increase the odds that I will be able to stick around as an investor for the stocks that I do own to compound for the longest period of time. If you understand the math of compounding, you know that the big gains come at the end of the period.

If you’re investing for 30 years, the biggest gains in dollar terms are going to come in the last couple of years. That’s how the math of compounding works. It just gets exponentially higher as time goes on. So to me, the number one thing that I want to do, and I think this is true for a lot of investors, is just maximize my endurance, maximize my durability as an investor. And I do that by having a reasonably high percentage of cash and having no debt. It’s not that I don’t want to take a lot of risk, it’s that I want to maximize for endurance.”

What does Housel mean by this? He is saying that compound interest sees its biggest value in the later years of compounding so your goal should be to never allow short-term events to stop compounding from working in your favour. These short-term events are the what if’s that could happen in life. Some examples are:

  • Loss of job
  • Major medical expenses
  • Something that causes you to not be able to work
  • Loss of a spouse
  • Sickness of a child
  • Your business closing
  • Many other unforeseen events 

For some reason, we all have this view that these types of things happen to others but never to us.
 
At some point in our lives, some drastic problem is going to happen, that is just how life works.
 
With a well thought out Barbell Strategy, you should have enough cash on the sidelines, or appropriate insurance in place, so you can handle whatever life throws at you without interrupting the compounding returns your investments are getting. This is where you can truly build wealth.
 
Housel continues with:
 
“The game that I want to play is acknowledging how ridiculously powerful compounding is and therefore increasing the odds that I will be able to stick around long enough for compounding to work. That’s the game that I want to play. And it might look conservative, but to me, it’s actually the opposite.”


“Most great fortunes are built slowly. They are based on the principle of compound interest.” – Brian Tracy


The Bucket Plan (for Decumulators):


Early on in my time at Amicus, I spent a lot of time calling people who were soon to turn 65 – these calls were to explain how KiwiSaver works, and how you can make the most of your investments in retirement.
 
I quickly realised that the labels fund managers are encouraged to use for investment options (conservative, moderate, balanced, growth, aggressive) were causing people to ‘pigeonhole’ themselves into investment strategies that may not be that appropriate (based on their goals).
 
Hear me out.
 
It is natural for someone nearing retirement to think about being more conservative with their investments. The idea of no longer having a paycheck, and drawing on your assets can be very uncomfortable, or even stressful…
 
I agree with and understand that perspective, but many of the KiwiSaver members I spoke to talked of moving every dollar they (often in a balanced or growth fund) into a conservative fund simply because that sounded like the ‘prudent’ thing to do.
 
Moving your funds to a ‘conservative’ fund or even a ‘cash’ fund is appropriate IF you expect to use the funds in the very near future (less than 3 years).
 
But, in most cases the KiwiSaver members I spoke to were not going to use their KiwiSaver immediately, and had never really considered that their investment horizon as a 65-year-old is still 20+ years (on average based on NZ mortality data) – they also hadn’t considered that being solely invested in ‘defensive’ or ‘conservative’ assets is akin to having all your eggs in one basket where they risked losing purchasing power over the long term (due to inflation).
 
I covered this concept in ‘When Being Conservative Can Be High Risk’ an October 2022 note to clients, but soon realised that we needed a framework to help clients invest more deliberately through retirement and not get caught up in the ‘labels’ and misconceptions associated with ‘growth’, ‘income’, or ‘defensive’ asset classes.
 
…Enter ‘The Bucket Plan’…
 
A ‘Bucket Plan’ may sound a basic, that is intentional. However, the concept is grounded in with solid fundamentals inspired by Asset Liability Matching principles utilised by large sovereign wealth and pension funds such as the NZ Super.  
 
At a high level, a Bucket Plan breaks your investment strategy into ‘buckets’ of assets that are matched with the timeline in which you expect to use the funds. The intention is to acknowledge the volatility of markets and provide defence, or stability in the short term, but to continue to have growth assets that generate positive inflation adjusted returns in the long-term (aiming to preserve your purchasing power).
 
Sizing your buckets – focus on desired income in retirement.
 
The typical makeup of each bucket is a multiple of one’s desired income during retirement. For example, the short-term bucket may be 4 times your desired retirement income of $50,000 bringing the total allocation of the bucket to $200,000.
 

  1. Short Term Bucket: Typically made up of 3-5 years of desired retirement income invested into extremely safe assets or risk mitigators like cash, cash funds, term deposits, or shorter duration bonds.
    • The rationale behind holding 3-5 years of income in this bucket is to provide certainty of near-term income and ensure income is not drawn from invested funds during economic slowdown. This buffer is intended to give you sufficient time to ride through any market shocks that occur – for more detail, see Happy Holidays – Into 2022… ‘What is the Downside?’
  1. Medium Term Bucket: Typically made up of 5 to 10 years of desired retirement income invested into income generating assets like bonds, property, infrastructure, high dividend paying shares or diversified income strategies.
    • The assets held within this bucket aim to generate cash through income and dividends to top up your short-term bucket as you spend it. An aspirational position may be to have sufficient funds in this bucket to generate income equivalent to your annual spending goals, if that is not possible, the idea is that these assets will generate modest capital gains over the medium term with income and can be sold down to replenish your short term funds as you spend in retirement.
  1. Long Term Bucket: Remaining assets invested in higher growth investments such as shares, listed property, or alternative assets.
    • The aim of these assets is to preserve the purchasing power of your investments by seeking to achieve capital gain much greater than inflation over the long term. This bucket will experience high volatility over the course of its investment but due to the allocation of the first two buckets, you have 8 to 15 years until you need to call on these investments.

 
As an investor traverses through retirement and draws down on their short-term savings, income and assets can be ‘rolled down’ from longer term holdings to shorter term as necessary.
 
This approach is designed to acknowledge that the future is uncertain and to all an investor drawing on their assets to maintain control in the short term, while being deliberately invested over the longer term.
 
The ranges and buckets outlined above differ client to client – when mapping out a bucket plan, we typically take into account 3 aspects:

  1. What is your risk tolerance? I.e. how much bad news and downside can you take before feeling compelled to take action?
  2. What is your goal? i.e. what income would you like to draw through retirement and for how long?
  3. What is your capacity to take risk? i.e. how much certainty do you need around your plans? If things don’t go so well for a period, could you pull back on spending or pick some work up to fill a gap?


At its core, The Bucket Plan is designed to help investors deal with the dilemma captured perfectly in two famous Shelby M.C. Davis quotes.
 
Acknowledging the idea that: “History provides a crucial insight regarding market crises: they are inevitable, painful and ultimately surmountable.”
 
But also adhering to the idea: “Invest for the long haul. Don’t get too greedy, and don’t get too scared.”
 
 
Conclusion:
If you have made it this far, thank you as usual for your time and attention. I trust that sharing these frameworks is useful, please feel free to share this, and please don’t hesitate to reach out if you would like to discuss how these frameworks can be applied to your situation.
 
Please feel free to book a meeting with your adviser through the calendar links below.
 
We’re locals investing for locals and are here to help.




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