Get The Buckets Out
Planning for retirement is the most challenging financial goal of them all. It is the only goal which requires planning right from the day we start planning for retirement up until the day we pass away. Retirement planning is usually carried out in two distinct phases. There is the accumulation stage where we save and invest systematically over the length of our careers towards creating an optimally sized retirement corpus. And then there is the withdrawal phase where we dip into our retirement corpus bit by bit every year to meet our expenses and maintain our desired lifestyle. Most of the attention with regard to retirement planning is paid to the accumulation phase and creating a retirement corpus. But very little emphasis is laid on managing that corpus post retirement. This usually ends up seeing us outliving our money. Therefore, it is important for us to ensure that we manage our retirement corpus effectively post retirement. And the best way to do so is the retirement bucket strategy. And the retirement bucket strategy is exactly what I am going to talk about in today's post. Right from why the retirement bucket strategy, what the buckets are, how much and what instruments should go into each bucket, and how to manage these buckets effectively.
To begin with, the retirement bucket strategy is the process of segregating our retirement corpus into parts and parking them in various product groups, based on the risk profile of each product group. Each product group can be called one of the retirement buckets. And each bucket helps provide for a particular phase of our post retirement lives. In light of the times we live in and the lifestyles we lead, the retirement age of the average individual has reduced from age 60 to age 55 or even 50 in some cases. Also, improved healthcare facilities mean that the life expectancy of the average individual has increased to anywhere between 85 and 90 years of age. This leaves us with a typical post retirement period of 35 to 40 years. Therefore, our retirement corpus would have to last us that long and help provide for our immediate needs while also ensuring steady growth for the future. And the retirement bucket strategy would help us satisfy both these requirements. Take the case of an individual who retires early at age 45 and has estimated expenses of Rs 10 lakh a year in retirement (after accounting for inflation) and a life expectancy of a further 45 years from the day of their retirement. Therefore the required size of the retirement corpus would Rs 450 lakh (Rs 10 lakh * 45) or Rs 4.5 crore.
The first 15 years' worth of expenses post retirement (Rs 10 lakh * 15 = 150 lakh = 1.5 crore) may be put into the first bucket which would be an income bucket. The money in this bucket should solely be oriented towards meeting the liquidity needs of the individual rather than generating returns. Therefore, the money allocated to this bucket would be parked simply in cash, savings accounts and fixed deposits. Pension schemes may also be considered as an option for this bucket if desired. To my common sense, a minimum of 15 years' worth of living expenses must be parked in the income bucket regardless of the life expectancy post retirement. This would ensure that enough money can be easily redeemed and is readily available for use as needed during the first 15 years post retirement. Next, the expenses for years 16 to 25 (Rs 10 lakh * 10 = 100 lakh = 1 crore) can be parked in the second bucket, which would be the low risk bucket. The money in this bucket would be oriented predominantly towards safety, with a steady but modest rate of capital appreciation. Hence the money would be invested in invested in high quality market linked debt instruments such as AAA rated corporate bonds, government bonds and gilt funds. The money in this bucket would therefore grow at a rate that is linked to inflation (inflation + 1-2%) while ensuring stability of the money invested.
The expenses required for years 26-35 (Rs 10 lakh * 10 = 100 lakh = 1 crore) can be put into the third bucket, which is the medium risk bucket. Since the money in this bucket would be required after a substantial period of time after the present day, it can be parked with an equal allocation to debt and equity. Accordingly, product choices for this bucket would include AAA rated corporate bonds, corporate debt mutual funds, hybrid mutual funds and large cap stocks/index funds/ETFs. The money in this bucket would therefore be built to a moderate risk construct and generate relatively higher returns on an inflation adjusted basis. The expenses required for years 36-45 (Rs 10 lakh * 10 = 100 lakh = 1 crore) provides the longest time horizon and also the greatest margin for risk. The money required for this period can therefore be put into the fourth bucket which is the high risk bucket. The money in this bucket would be allocated almost entirely to equity. Accordingly, product choices for this bucket would include large cap stocks, mid and small cap stocks/index funds/ETFs/mutual funds, aggressive hybrid mutual funds and so on. Naturally, this bucket would be the most volatile of all the buckets. But they would also generate optimal long term returns on an inflation adjusted basis. All 4 major retirement buckets have been represented in the graphic below.
With the various buckets and the relevant product choices within each bucket sorted, let us look at some other important aspects of the retirement bucket strategy. Firstly, the retirement bucket strategy is essentially designed to help those of us who would depend solely on the growth and income generated by their portfolios to meet their needs in retirement. Once we decide to employ the strategy, the next challenge to tackle would be the effective management of these buckets. The work involved in case of a retirement bucket strategy would begin well before we actually retire. We would need to have complete clarity on the specific products we would like to include in each bucket at least 5-10 years before our intended age of retirement. The actual exercise of shifting our money into these buckets may begin when we are a year or two away from our intended date of retirement. And the work does not end when our money has been moved into the buckets. They must be managed on a real time basis based on how events play out in the real world. For example, in case of a significantly productive run for equities, we may take some money out of the medium and high risk buckets and park it in the low risk or income buckets. On the other hand, in case of a market crash money may be moved from the income and low risk buckets to the medium or high risk buckets at the individual's discretion. Also, the income bucket must be replenished regularly as and when it gets emptied by shifting money from the low risk bucket.
In conclusion, the most common reason why retirement corpora (plural form of corpus) don't last is because they are not managed effectively post retirement, rather than them being inadequate. Therefore, it is just as important to have a process to manage and withdraw from our retirement corpus post retirement as it is to have a process to create it. During the post retirement period, a retirement corpus should be managed in such a way that it guards us against facing a liquidity crisis today, while always ensuring that we have enough at our disposal for the immediate and long term future. And the retirement bucket strategy facilitates and balances both these requirements, especially when we are completely dependent on our portfolios to meet our financial needs. All we need to do once we have the buckets in place is to manage the buckets based on real world events and our requirements at a given point of time post retirement. And given the structure and flexibility that the retirement bucket strategy bestows upon our retirement corpus, managing our money post retirement would become a lot less challenging as an exercise than it otherwise would have been.