Many financial experts believe that the bucket approach to retirement portfolio management may work better over alternatives such as systematic withdrawals and flooring.
Retirement is believed to be a golden period in one’s life for various reasons. There is finally ample time to pursue hobbies and interests that had long been forgotten in the hectic corporate life. But it’s also the time when your income will stop, but your expenses will either remain the same or increase. While you may look forward to enjoying the post-retirement years, financial crunch due to lack of adequate planning can dampen your expectations from your retirement life.
What is the bucket approach to retirement planning?
When it comes to retirement income planning, most people tend to take a linear approach. New-age experts, however, believe that the bucket approach to retirement portfolio management may work better over alternatives such as systematic withdrawals and flooring. Pioneered by Harold Evensky, the key advantage offered by this particular strategy is that it doesn’t follow a one-size-fits-all model. There are quite a few versions of the bucket strategy, but the basic concept is to create a diversified portfolio with three distinct time horizons or buckets –
1) The first 5-10 years of retirement,
2) The next 5-10 years, and
3) The remaining years of retirement
Segmenting your retirement phases into different buckets based on their time horizons will facilitate the right asset allocation of your retirement corpus. For each bucket, you need to build a portfolio that can meet your financial needs during that time. Needless to say, the portfolio for the first bucket should be highly conservative as it will pay for your immediate expenses. The second portfolio is not intended to cover any expenses until the first 5-10 years and hence can be allocated to a combination of growth and income assets. When it comes to the last bucket, you can take a more aggressive and growth-oriented approach towards your investments as you don’t need that money for 10-20 years.
What to put in each bucket?
The portfolio for the first 5-10 years should feature safe income assets, i.e. short-term debt investments like FDs, Liquid and Ultra-Short Term Debt Mutual Funds. It is recommended that the first bucket should not contain any high-risk investments. The second bucket can have a mix of debt and equity to give it a growth kicker. Debt can be held as Short Term or Medium Term Debt Funds and for equity one can use Balanced Advantage Mutual Funds but avoid investing directly in stocks. You can afford to take a little risk during this period as you would still have enough time to recover even if the investments perform badly for a certain time. Ideally, the third portfolio should be mostly, if not fully, in equities, considering you would not need this money for around 10-20 years. Good choices for this would be Large Cap Funds and Multi-cap funds. 3-4 Mutual Funds from reputed fund houses for each type of investment should be enough for diversification.
Is this the right strategy for you?
While the bucket approach offers peace of mind, it is not without drawbacks. To begin with, there is no certain way of knowing if your estimates are accurate. For example, you can miscalculate the expenses you would have to bear once you retire. Apart from that, the thought of putting a major chunk of your assets into equities for long-term growth at the age of 80 may not seem appealing to you. In fact, the older you become, the riskier your allocations get. This is why it’s crucial to design a customized bucket strategy that caters to your income (pension) and risk tolerance. You can even re-bucket your investments after 10 year intervals to suit your needs. Overall the bucket strategy is a good way to allocate your assets across three or more timelines. However, you need to modify the plan accordingly to adapt to changes in markets and your financial situation.
(By Ankur Choudhary, Co-Founder and CIO, Goalwise.com)