Retirees will face different types of risk during retirement when they are drawing down their retirement fund.
1. Longevity Risk – Risk of running out of money
2. Inflation Risk – Risk of decreasing purchasing power
3. Market Risk – Risk of no access to money during market downturn
4. Withdrawal Risk – Risk of overspending
With market volatility and low return environment in the future, retirees will face challenges and would require proper financial planning to ensure that they have sufficient income during retirement. In this article, we will like to show how retirees can do that.
The bucket approach which is to divide your retirement portfolio into several different buckets with transfers between those buckets carefully structured. The first bucket contains cash and liquid assets to fund several years of retirement with other buckets containing riskier assets. The first bucket would be replenished when risker assets perform well. The bucket approach will help to insulate the retiree from concern from a bear market which will affect their retirement.
The traditional alternative to bucket strategies is to have just one retirement portfolio, or bucket, divided between cash and riskier assets according to a predetermined allocation – say 60% stocks, 30% bonds, 10% cash. A key part of these non-bucket portfolios is the regular balancing that takes place to bring allocations back in line with the intended allocation.
The study that provides analysis of bucket strategies by Javier Estrada, a professor at University of Navarra’s business school in Barcelona shows that the portfolio with 60% allocated to stocks and 40% to T-bills is the best performer. However bucket strategies have an average of 4-5% failure rate when compared to 60% stocks/ 40% T-bill combination. Why is that so? It is due to periodic rebalancing undertaken periodically by non-bucket strategies. Rebalancing will involve selling assets which outperform and buy assets which underperform. Hence, we need to introduce rebalancing within the different buckets.
Here’s what we will recommend using bucket strategies, taking below example for illustration purpose.
– Break down into 7 buckets. 2nd bucket will be invested during the 1st 5 years of retirement, 3rd bucket will be invested for 10 years, 4th bucket will be invested for 15 years, 5th bucket will be invested for 20 years, 6th bucket will be invested for 25 years and last bucket (7th) will be invested for 30 years.
– The first bucket contains cash to draw down for 5 years. Once the cash is depleted, cash will be transferred in from other buckets at the end of their investment period.
– At the end of 30 years, all buckets will be depleted based on the minimum sum planned.
This method will be supplement with CPF Life and SRS (if any) to create the base of the retirement income. For 2nd to 7th buckets, the investment are to be rebalanced annually. If the retiree will like to leave a legacy for future generation, the 7th bucket can be constructed specifically for that purpose.
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