‘The bucket theory’ or retirement fund management is easy to understand and I have a few well established and running implementations.
The bucket theory is simple – set up 3 buckets of debt, balanced, and equity. Keep emptying one and life will be fine, right? Well not so simple. Lets ask some questions:
- will you go for a dividend option or growth option?
- if your income is greater than your expenses, how will you reinvest the excess?
- in a long bull run will you sell some equity and build a bigger debt buffer?
are there simple answers available for these questions? The way some people – especially advisers – have been handling SWP from equity as the best way to handle retirement requirements, ignoring standard deviation of equity returns is scary. I have handled it in a classroom and found it worrisome, hence the post.
A lot of US based research favors a high equity portfolio – remember they are having a 225 year low debt yields – but it may not be true for India. IN a country where the yields are negative in debt, it is obvious that equity will be the only choice. In fact the SnP 500 pricing is now getting to the point of being hilarious. People are NOT looking for growth, but they are hoping for a yield better than the 10 year bond. This is a different topic, but let us stick to India. An increasingly volatile portfolio may not suit an older INDIAN investor – who has no Social security to fall on – seeking a steady-as-she-goes portfolio. And what if bucket 3–stocks–happens to be depressed when it comes time to tap it for living expenses? Or not having money for a big medical emergency?
Withdrawing money from an asset while it’s declining will almost never be a good idea – especially in a retiree portfolio.
So, as an IFA or as a DIY you will have to answer the following questions:
- How will you create cash flow from the 2-3 buckets of assets that you have created? Most retirees like to live off their income and leave the portfolio untouched till they are in their late 80s or perhaps not at all. However this could become a challenge if the interest rates keep falling down. Imagine trying to withdraw money when interest rates are 2% for a 10 year paper!! What are the options? a) put all investments in growth mode and withdraw from where ever the returns are above the long term average of that asset class or b) keep drawing from bucket 1 (nsc, ppf, sb account, bank fd..) and whenever you think fit, shift some money from other buckets to the first bucket c)put money in the dividend mode and use the excess of income over expenses for re-balancing.
- Will Equity increase in your portfolio or decrease? as you live off your debt funds, the value of the equity portfolio will keep increasing. At this stage what will you do? Will you perforce shift money from equity to long term debt funds or let the value of the portfolio keep going up? Suppose you have a client aged 84 years and has Rs. 4 crores in equity and about Rs. 2 crores in debt oriented funds. His annual expenses are about Rs. 5L p,a. – will you say..he needs only about 1 crore in debt to achieve his life time goals..so let me shift 1 crore to equity? OR will you shift everything to a SAVINGS BANK ACCOUNT and decide ‘why bother about volatility’. I have done a post earlier about portfolio re-balancing and bucket theory.
- When will you tap which bucket? If you are living off the income generated by your portfolio (and by implication your portfolio is not getting re-balanced) – when will you tap which bucket? Will you try to get money by re balancing or just by a plain withdrawal in equal proportion or just a quick dip into the bucket 1 – the debt and liquid bucket?
- At what age will you seek professional help to handle your portfolio?
- If your equity portfolio has direct equity when do you think you will need a professional investment adviser?
- If you cannot handle a direct equity portfolio will you shift to an index fund?
Now add your questions too.
Secret: Bucket theory is far more complicated than what people believe..
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