Can I use a simple equity + debt portfolio instead of multiple retirement buckets?

A reader asks, “Can I use a simple equity + debt portfolio instead of multiple retirement buckets? Won’t this be easier to manage?”

When I was younger, I would have agreed with the reader. Age and experience change perspective. See: I thought a pension was unnecessary, but age taught me a lesson on retirement planning! And unsurprisingly, the person who asked this question was a young man.

He asked the above question following the description of buckets here: How to create retirement buckets for inflation-protected income.

The freefincal robo advisor tool recommends using four buckets: An income bucket with guaranteed income for the first 15 years in retirement and low-risk, medium risk and high-risk buckets that would be used to fill the income bucket in subsequent years.

Here are some illustrations. A full-feature description is also available.

• I am 30 and wish to retire by 50; how should I plan my investments?
• Retirement plan review: Am I on track to retire by 50?
• How to use the freefincal robo advisory tool to track the progress of our financial goals
• Can I retire by age 55? Retirement Planning Case Study
• Case Study: Achieving Financial Freedom for Early Retirement
• How should I plan if I want to retire in 20 years?
• Is it possible to combine a bucket strategy with income laddering after retirement?

As an example, consider:

1. A liquid fund for inflation-protected income
2. A conservative hybrid fund representing the low-risk bucket.
3. A dynamic asset allocation fund as the medium bucket
4. An equity fund or an aggressive hybrid fund makes the high-risk bucket.

So, that is just four funds to manage a retirement portfolio.  This is NOT a recommendation; it is only an arbitrary illustration to point out that a “bucket” is what you call it!

Sure, it can be made even simpler with just two funds (equity and debt) or even a single hybrid fund. But will you put all your corpus in just one or two funds? Even if you call it a single bucket or a single portfolio with equity and debt, there are likely to be 2 to 3 funds in each asset type.  What you call a single bucket, I can say, are multiple buckets.

Retirement buckets are arbitrary mental divisions. You can split them up any way you like or combine them any way you like and even think of them as the same portfolio.

A retiree can hold four debt and four equity funds and claim they have no buckets, just one portfolio. Or he could claim he has distributed his eight funds into four different buckets. It is only a point of view. The maintenance and effort are just the same.

Why split our investment as buckets after retirement?

1. To emotionally handle sequences of returns risk better. Any large crash or a poor run of returns from equity at the start of retirement can hamper our ability to beat inflation.
2. As a retiree, I need peace of mind. I need to know that come rain or shine, I can fight inflation for X years after retirement. The income bucket essentially guarantees this for the first 15 years.
3. In addition, any income from pension, rent, etc., forms what is known as an income floor, further cementing our peace of mind. See: Creating the “ideal” retirement plan with income flooring!
4. During these 15 years, the rest of the corpus grows. Most of it is in debt and 20% to 40% in equity, depending on the profile of the retiree. This allows us to reasonably combat poor equity sequences of returns (poor returns after five years, seven years, etc) in the remaining buckets. Also, the low-risk bucket will be least affected by equity as it has the least exposure, and the other buckets will have additional time to grow (another 7-10 years for the medium bucket and 14-20 years for the high-risk bucket).
5. Yes, these are arbitrary mental subdivisions, but once I make them, I can face market downturns and crashes easily.

You may ask, “Suppose I hold 75% debt and 25% equity. I will withdraw an inflation-protected income from the debt component, allowing the equity to grow untouched for as long as possible. I will rebalance once a year. This also should take care of the sequence of returns risk, should it not? Why complicate matters with buckets?”

The short answer is yes, it is most definitely possible. You are using two buckets – one for equity and one for debt. And that debt bucket is likely to have compartments since all the money is unlikely to be invested in the same type of debt instrument. Unlike the above example, your model has no rules on when to use which bucket, where the sequence of use is pre-defined.

We do not and cannot claim ours is better. However, we believe that the bravado of a young investor to keep things simple but fuzzy often vanishes with age, and 45+ retirees prefer something more concrete, even if it needs to be elaborate.

Dividing a portfolio into buckets is only a point of view. Whether we do it or not, we need to address, “What will I do if returns from equity are 0% after ten years?” and come up with an answer better than “I will wait it out and use my debt for income”.

The most practical way to handle this risk (buckets or no buckets) is to minimize equity exposure even if we retire early. Of course, this would mean a higher corpus, but it is better to be safe than sorry.

Another issue people have about “retirement buckets” is management. To some, the above plan sounds like a retiree has to follow market movements and time the entry or exit from buckets. This is incorrect. No such action is necessary. Just a simple annual rebalance is all that is required.

Using buckets can cement inflation-protected income for longer and longer durations. Imagine a year when the stock market doubled in value. So, our high-risk bucket would have doubled in size (X to 2X). We could take 0.5X and shift it to the income bucket and 0.5X and shift it to the low-risk bucket. Again, these are only mental subdivisions but can differentiate between calm and panic. You can play this game with our Retirement Bucket Strategy Simulator.