A reader says, “I am 50 years old and have been planning to retire at this age since quite a few years back. By god’s grace and my regular investments, I have managed to have a decent corpus, which I have validated using your robo-advisory tool. Thanks a lot for making this tool and helping so many”.
“One big argument between my wife and me is about where to invest the funds to generate income for the first 15 years. As an avid DIY investor, I want to keep it simple with plain liquid funds. In contrast, my wife suggests putting all in FD so that the capital is always preserved and we can enjoy the interest returns alone”.
“My wife is asking why not invest the entire retirement corpus in FD. While I can make her understand the need for better investment options post the initial 15 years to tackle inflation with time on our side, I am confused about deciding between FD vs Liquid Funds for the initial 15 years”.
“I understand the impact of inflation + taxation on both my choices. I am a moderate investor, with my retirement corpus asset allocation 50:50 towards equity vs debt”.
“I would appreciate it if you could help me to decide what to choose. Also, I am unsure if any freefincal article discusses this specific scenario. It would be great if an article could also be made which could help many people. Thanks”.
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First, let us explain why 15 years. Why this specific number? This stems from the retirement bucket strategy recommended by the robo tool.
A bucket strategy is a post-retirement investment plan to manage inflation-protected withdrawals (income) and investments for the near and long term. So, we have investments purely for income generation (regular withdrawal), fixed income, and equity investments.
Retirement buckets are mental partitions of these investments. The primary rule in our robo advisory tool is that the retiree should have enough money to generate inflation-proof income for the first 15 years of retirement. If this is not available, creating a bucket strategy is quite risky. A few years of poor market returns, especially in the first few years of retirement, can wipe out much of the corpus.
The robo tool divides the retirement corpus into five buckets. That is, the retirement corpus will be divided into five parts. This is only one of many ways to construct a bucket strategy. The idea here is to minimise active management and shift funds from one bucket to another unless necessary. The following assumes 45 years in retirement. The percentages are specific to the set of inputs and should not be used by everyone.
- An emergency bucket to handle unexpected expenses. Example: 5%
- An Income bucket for guaranteed income for the first 15 years of retirement. During this time, investments are made in the following three buckets. Example: About 40-45%. This is the bucket mentioned in the reader’s question.
- Corpus from a low-risk bucket that provides retirement income from year 16 to year 26. To provide this income, the low-risk bucket will have an asset allocation of 30% equity and 70% debt during the investment period (years 1 to 15 of retirement). Say about 25%.
- Corpus from a medium-risk bucket will provide retirement income from years 27 to 35. To provide this income, this bucket shall have an asset allocation of 50% equity and 50% debt during the investment period (year 1 to year 26). Say about 10-15%.
- Corpus from a high-risk bucket will provide retirement income from years 36 to 45. To provide this income, this bucket shall have an asset allocation of 70% equity and 30% debt during the investment period (year 1 to year 35). Say about 10-15%.
- After 15 years, the low-risk bucket will be turned into 100% debt and provide income for about 11 years. After that, the other buckets will also be progressively used. One can always customize this usage after retirement.
Illustrations:
- Retirement plan review: Am I on track to retire by 50?
- I am 30 and wish to retire by 50 how should I plan my investments?
- 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?
Now, let us first answer the reader’s question. The income bucket is meant to provide inflation-indexed income. Therefore, by definition, it should erode in value over time. Preserving the principal and living off the interest will not help tackle inflation.
Therefore, we recommend using liquid funds, money market funds and perhaps some exposure to arbitrage funds for the income bucket. These are more tax-efficient than FDs. Note: Even though FDs and debt funds are taxed at the slab rate, we only pay tax on redemptions for debt funds. For an FD, the entire principal is taxed whether or not you withdraw.
We recommend you explore using the freefincal robo tool if your corpus is large enough to accommodate an income floor or a laddered annuity.
An income floor is a guaranteed income for life via an RBI Retail Direct Govt bond or an annuity scheme (sold by life insurers). This will give the retiree (in this case, your wife) peace of mind that the income is guaranteed. Also, if you buy a government bond, the principal is preserved and can be passed on.
However, only some portion of the corpus should be used for this. The remaining corpus should be invested in buckets (use the robo tool to find this out)
In the case of a laddered annuity, a new bond or annuity is purchased every ten years or so to increase the guaranteed income. However, this will further increase the corpus required for retirement. See: What is annuity laddering in retirement planning? The key idea here is that as we age, the annuity interest becomes higher (RBI bond interest will not increase).
Therefore, we recommend determining if you can afford an income ladder (the robo tool allows you to vary the income level from 0 to 100% of your annual expenses in the first year of retirement). If you can, you can increase your retirement corpus’s safety and, more importantly, address your wife’s concerns.