Contrary to popular assumption, we actually don’t need regular income in our retirement years; instead, we need cash flow, or an income stream that keeps up with inflation. The solution to maintaining the cash flow is to design a portfolio that focuses on returns and not on fixed interest payments.
In order to do so, one can diversify his/her portfolio more effectively and protect himself/herself from inflation and the real risk of outliving his/her assets by using a bucketing strategy.
This strategy involves dividing one’s retirement portfolio into different buckets based on one’s investment goals and time horizons.
Bucketing strategy can help one manage his/her risk, ensure liquidity, and earn better returns. Here is a breakdown of the three key buckets one should consider when planning for retirement.
Bucket 1: Cash And Liquid Investments
The first bucket in your retirement corpus should be allocated to cash and short-term investments. This bucket should hold the money you need to cover your expenses for the next two-three years. It should be highly liquid and easily accessible, as you may need to withdraw from it frequently to cover your living expenses. For instance, if your monthly need is Rs. 30,000, you can park around Rs. 10 lakh in an instrument which is highly liquid in nature.
This bucket should include your savings bank accounts, money market funds, such as liquid funds, and short-term bond funds. These investments are low-risk and provide a stable source of income. While the returns may be modest, they offer the stability as well as liquidity that you will need for your short-term expenses.
Bucket 2: Conservative Investments With Higher Returns
Once you have secured the first three years of cash flow, you will need to manage the cash flow for the next 5-7 years. This technically means you need to plan for the next 3-8 years. This bucket should hold the money that you will need to cover your expenses for the next 4-10 years. This way you will have clarity on the timeframe when you require the cash flow. This will also define your risk to an extent, as you will not have any other income to support your retirement.
Since you will need to completely rely on your retirement savings, there will not be any scope of taking risk. You just need to tackle inflation.
The second bucket in your retirement plan should be allocated to conservative investments, such as bank fixed deposits and conservative hybrid funds. The advantage of holding the combination of fixed deposits and conservative hybrid funds will help you to synchronise the cash flow from your bank fixed deposits with the smaller equity component in conservative hybrid fund, which will help you tackle inflation.
Bucket 3: Growth Investments
Now that you have already planned the cash flow need for the first 10 years with the two buckets, the third bucket in your retirement plan should be allocated to growth investments.
This bucket should hold the money that you will need to cover your expenses for the next 10 or more years. It is designed to provide growth and higher returns over the long term.
The conventional strategy of parking your retirement corpus in bank fixed deposit will pose a big threat on retirement cash flow in the long run. This is because no bank will offer fixed deposits beyond 10 years, and if you deposit today at a higher rate, there is no guarantee that you will get the same rate after 10 years.
In this condition, it becomes important to invest in an asset class, such as equity, which offers higher growth in the long term. In this bucket, you may like to add the flavour of equity to give a kicker to your return in your overall portfolio.
Equity as an asset class is more volatile, but they also offer higher returns over the long term. This bucket should include diversified portfolio mutual funds. The advantage of investing through mutual funds is that they will help you mitigate the risk associated with individual stocks.
If you want to play safe, you can add equity-oriented hybrid funds, or else, invest in a combination of diversified equity fund, index fund, and equity-oriented hybrid funds.
How It Helps
Bucketing will not only help you manage the cash flow, it will also help you to better earn your returns.
There are broadly two ways in which you can bucket your retirement portfolio – time-based bucketing and asset-based bucketing.
Time-based bucketing strategy will allow you to manage risk and liquidity based on your retirement goals and timeline, while asset-based bucketing will help you to manage risk and liquidity based on the asset classes that are most important to your retirement goals
