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  • Writer's pictureAkshay Nayak

Fill The Buckets Up

The Retirement Bucket Strategy is one of the most popular and widely recommended strategies when in comes to managing our portfolios in the lead up to and after retirement. The Retirement Bucket Strategy is one where our retirement corpus is broken into various chunks to provide for various phases in retirement. And each chunk is parked in a variety of investment products, based on the needs each chunk is expected to provide for. One of my earlier posts, Get The Buckets Out focussed on the basics of this strategy. Those coming here for the first time may feel free to have a look at it before proceeding to read what I have to say today.

I discussed the broad approach and ideal product categories for each bucket in my earlier post on the subject. But, there are a number of considerations that need to be made before adopting the strategy. Also, the actual process involved in constructing, shifting money between and withdrawing from each of these buckets may change based on the individual to whom the strategy is suggested and the nuances of their financial needs. And these are the aspects I will focus on today, with an aim to provide a well rounded view of the Retirement Bucket Strategy.

There are two broad sources of income that individuals tend to enjoy post retirement. Income received from employer and government sponsored retirement benefit schemes such as social security, Provident Fund, NPS and so on can be classified as non portfolio income. Some other sources of non portfolio income have been listed in the graphic that follows.

On the other hand money received in the form of dividends from stocks, interest income from bonds and redemptions from available investments can be classified as portfolio income. Non portfolio income serves as a source of guaranteed minimum income in retirement. The gap between our estimated expenses expenses in retirement and total non portfolio income gives us the amount of income our portfolios would have to replace. Therefore, the extent of this gap becomes the first important factor we would have to consider before adopting the Retirement Bucket Strategy.

If guaranteed non portfolio income accounts for 60-70% of our spending needs post retirement, it allows for more risk to be taken when constructing our retirement buckets. If we find ourselves being dependent mainly on our portfolios for income in retirement, it means that we must be a lot more cautious and pragmatic when constructing and structuring our retirement buckets. Along with this our age at retirement, life expectancy post retirement and risk profiles would also have a significant bearing on how we go about employing the bucket strategy.

Before understanding how the bucket strategy can be applied to various individuals, take a look at the graphic below for a quick understanding of the buckets that are most commonly used when employing the strategy.

Those of us who manage to retire relatively early (say between age 45 and 50), have a reasonable post retirement life expectancy of 35-45 years post retirement, with a moderate to aggressive risk profile can have a reasonable portion of their retirement corpus allocated to the medium and high risk buckets. The assets in these buckets are relatively riskier compared to traditional investment avenues and would therefore suit the needs of such individuals. On the other hand, those who have a normal or late retirement or a relatively lower life expectancy cannot afford to take on a lot of portfolio risk.

Such individuals should therefore allocate most of their retirement corpus to the income and low risk buckets, with minimal allocations to the medium and high risk buckets. In fact, there may even be cases where the most prudent choice would be to allocate the retirement entirely to the income and low risk buckets with zero allocation being made to the medium and high risk buckets. There are also a number of nuances that need to be considered when constructing each retirement bucket. The most important consideration when looking to include assets in a particular retirement bucket is to understand the purpose of each bucket.

Then we would need to pick assets which would deliver a positive return while achieving the purpose for which each bucket is set up. The purpose of the income bucket is to provide capital preservation and adequate liquidity post retirement. And the assets that are ideally suited to meeting these needs are cash and near cash assets such as savings deposits and liquid funds. These assets are not exposed to the risk of volatility in their value, meaning that they would not deliver a negative return. Therefore the income bucket must be constructed solely with these assets.

The low risk bucket is designed to primarily preserve capital, but with a marginally higher risk adjusted return as compared to the income bucket. Therefore, the most ideal choices of assets for inclusion in this bucket include high quality bonds and low duration debt funds. Those who wish to hold individual bonds in this bucket would be better off holding tax free bonds offered by various government authorities such as NHAI and REC. The medium risk bucket is meant to achieve a balance between security and growth. Therefore, this bucket may include reasonable exposure to equities in the form of well established, dividend paying large cap stocks and large cap index funds.

The high risk bucket serves as the engine for long term growth of the retirement corpus and should therefore be entirely parked in equities in the form of stocks and mutual funds across all market capitalisation categories (large, mid and small cap). But though the Retirement Bucket Strategy is simple and breaks a retirement corpus down into chunks for various phases in post retirement life, it does not eliminate the need for active management. The money in various buckets must be actively managed to meet the individual's needs.

Let me now substantiate all of this with examples. Take the case of an individual as shown in the graphic that follows.

In this case, the individual has retired relatively early and has a fairly high life expectancy post retirement. Also, their guaranteed non portfolio income amounts to exactly 70% of their annual spending needs post retirement. This means that their dependence on the retirement corpus for income in retirement is likely to be minimal at best. This clearly means that they can afford to take on greater risk when implementing the bucket strategy and allocate some money to all buckets including the riskier ones. An illustrative example of the same is given in the graphic that follows.

Remember that the figure above is only illustrative. In practicality, there may be another way to approach the situation. Because the retiree only requires a portfolio income of Rs 60 lakh through their retirement years, (Rs 1,50,000 * 40 years), this amount can be parked in the income and low risk buckets. The remaining portion of their retirement corpus can substantially or completely be parked in the medium and high risk buckets. Now let us take the case of a retiree who would have to adopt a conservative approach to implementing the bucket strategy. Look at the facts in the graphic that follows.

Though the retiree in this case has an adequately sized retirement corpus, they are significantly older than the retiree in the first case. Their post retirement life expectancy is also significantly lower, and they are dependent on their portfolio for 60% of their post retirement spending needs. All of this means that they can afford to take very little risk, if any, when implementing the bucket strategy. Therefore, their retirement corpus would have to be parked completely in the income and low risk buckets as illustrated in the graphic that follows.

For slightly enhanced protection against inflation, a portion of the money in the low risk bucket may be parked in conservative hybrid mutual funds which predominantly invest in debt, with a minimal allocation to equity. But that is about all the room that the retiree would have to take on risk in this case. Those who can take on moderate risk and are equally dependent on non portfolio income and portfolio income in retirement may park a significant portion of their retirement corpus (say 60%) in the income and low risk buckets with the remaining portion being parked in the other two buckets.

Those who decide to implement the strategy would be best served doing so with help from a competent financial planner. Financial planners would help us understand our sources of non portfolio income, decide how much income is required from our portfolios, assess our risk profiles and implement the strategy accordingly. When employing the bucket strategy, it is important to ultimately remember that while the strategy is flexible and intuitive, expecting it to generate the highest possible return would be unrealistic. It is built on moderation and sound asset allocation principles. Therefore, we can expect the strategy to allow us to enjoy a comfortable and stress free retirement, if not a glorious one.

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