Bucket strategies – or time segmentation of assets – is a very nice and easy way of explaining to the end user how it works. However, this is making an assumption that the client has paid attention when the IFA was explaining, and the Ifa himself has understood the risks of Bucket strategies (TS).
First of all this strategy creates a drag on the assets. Unlike a Total Return strategy which is far superior, TS expects you to keep more money in lesser yielding assets for a long period of time. So for people with lesser money the drop in the value of the portfolio (or the slow growth may hurt more).
Let us look at a 50 year old retiree having about Rs. 1 crore in total investment assets.
He/she has been forced to give up their income source, they have no other major expenses (or it is provided for separately) and has expenses of Rs. 60,000 per month.
Given Indian short bond returns of say 6% p.a. she should keep about say 4 years expenses in short bond funds, liquid funds, and bank fixed deposits. That means about Rs. 30L goes into the least yielding bucket.
As a safety precaution we need to keep another 3 years expenses in the second bucket which means about 22L in this bucket.
This leaves us only Rs. 48L available for the equity and very long bond bucket.
Does TS reduce risk in the portfolio? NO. It does not. It eliminates sequence risk in the equity portfolio. Which means if there is a bear phase from the date of investing for the next 11 years, the investor need not panic. Need not panic can also mean should not panic.
However many clients are prone to panic – especially at this stage of their life. What if the client-ifa relationship is new and the client has the following problems:
- K Wealth Managers come calling on her and scare her about a longer bear run?
- C Gold WDM come calling and want to sell a CAPRO product esp in a down market?
- What if her brother in law is strongly recommending a M portfolio manager?
- What if she reads the pink papers which say “PPF has been better than equities”
- What if her neighbor
- sees her portfolio and says ‘are you not scared’? innocently?
- What if her son/daughter qualify and say “total return” portfolio is better, lets break this?
there are a lot of behavioral risks in TS and TR strategies..because the asset allocation may not match the text book asset allocation.
So the assumption that TS is better than TR is not right. TS is easier to explain to the investor. TS will work if the assets are large and even if the investor panics, he/she cannot do much damage. Not much damage in a retiree portfolio means he/she will still sleep well.
I have done long lectures on TR and TS – and I find it difficult to explain this well to older retirees, and to many IFA too.
Ha. Who said Retirement is easy?
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