How to create retirement buckets for inflation-protected income

Published: July 31, 2021 at 8:10 am

This article discusses how to distribute a retirement corpus into different segments, aka buckets, to generate inflation-protected income. This stems from a YouTube comment from Anil Rai.

“Dear Dr Pattu, I am a silent subscriber of your excellent posts. This is my 2nd comment post in the last 1 year. This video (linked below) is one of the best. However, for the sake of completeness, it would be very useful for viewers if you can give options/choices of mutual funds or other financial instruments for bucket 1, bucket 2, bucket 3 and bucket 4. I know you have talked about return % and deviation % of various categories of mutual funds. But it will be useful to make part 2 of this video with options/instruments/ avenues to invest into for bucket 1 to bucket 4”.

What is a retirement bucket strategy? We have seen how our parents and grandparents manage their money after retirement. For most of them, a pension would be the main component. The remaining corpus would be distributed among senior citizen saving schemes, PMVVY, monthly income schemes, fixed deposits etc.

The main purpose of this is to obtain constant income after retirement with some liquidity to handle small emergencies. Most of them did not have enough corpus to try and fight inflation – that is, an increase in day to day expenses – after retirement.

A bucket strategy also has a similar structure: pension + income-generating investments from which we can draw more if our expenses increase + investments for capital appreciation. Each category is referred to as a bucket. Regular maintenance is also necessary. That is moving from one bucket to another depending on asset allocation or market conditions to reduce risk.


Key factors to consider while building retirement buckets

  1. Mindset is key. Out retirement may be years away, but we need to prepare ourselves to beat inflation using retirement buckets.
  2. How much of the corpus is liquid? That is freely redeemable.
  3. If the first 10 years in retirement involve a stock market crash or a side-ways movement with poor returns, will your corpus deplete too much?
  4. If interest rates decrease, will our income decrease?
  5. If rates increase, can we capitalise on that?
  6. Can we handle unexpected expenses?
  7. How tax-efficient are the investments?
  8. Who will manage the buckets? Ourselves? A professional? Is there someone else in the family who can step in for us?
  9. What is our experience with equity and bond market products?
  10. What is the level of understanding of risk in these products?

We shall assume here that enough corpus is available either now or in future for a bucket strategy. For a full retirement planning illustration, please consult: I am 30 and wish to retire by 50; how should I plan my investments? Or How much do I need to retire by 45 in India?

The primary thumb rule we follow in our robo advisory template is, the retiree should have enough money to generate inflation-proof income for the first 15 years in 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 template 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. This assumes 45 years in retirement.

  • An emergency bucket to handle unexpected expenses. Example: 5%
  • Income bucket providing guaranteed income for the first 15 years in retirement. During this time, investments are made in the following three buckets. Example: About 40-45%.
  • Corpus from a low-Risk bucket that provides income from year 16 to year 26 in retirement. To provide this income, the low-risk bucket will have an asset allocation of 30% equity 70% debt during the investment period (years 1 to 15 of retirement). Say about 25%.
  • Corpus from a medium risk bucket will provide income from year 27 to 35 in retirement. 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 income from year 36 to 45 in retirement. 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%.
  • During this investment period, the buckets will be actively managed to reduce risk: rebalancing and profit booking from one bucket to another. To understand how this works, try this: The Retirement Bucket Strategy Simulator.
  • 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.

This is a schematic from a previously published illustration: Creating a retirement income plan for 27-year old Amar. Please note that bucket allocations will change as per the user’s age profile, and these would be auto-determined by the robo template.

retirement income strategy with buckets
retirement income strategy with buckets (only one possibility is shown here)

Financial instruments for the buckets

Now to address the question by Anil Rai.

Income bucket:

  • Pension. Guaranteeing some percentage of our expenses via a pension is always advisable. This is known as income flooring. Read more about it: Creating the “ideal” retirement plan with income flooring!
  • Fixed deposit ladders or bond income ladders. A series of fixed deposits or even short-term bonds that mature in successive years. They can be used to provide income each month (or every six months in the case of bonds) or after maturity (as applicable).
  • Post office monthly income schemes
  • PPF
  • Money market mutual funds; liquid funds, or arbitrage funds
  • A stable equity portfolio offering decent dividends can also work for those with experience.

Please note that the income bucket will have multiple components.

The low-risk, medium-risk and high-risk buckets only vary in equity allocation. Their main purpose is the same: capital appreciation. The main difference is the duration of the investment. In the above example, the low-risk bucket has a tenure of 15 years.

That is, the bulk of the low-risk bucket is expected to grow untouched for 15 years.  Similarly, the medium-risk bucket has an expected tenure of 25 years and the high-risk bucket a tenure of 35 years in the above example.

Depending on market conditions, the retiree will shift some funds from one bucket to another in the intervening period. For example, from the high-risk bucket to the low-risk bucket when there is a bumper return or from the medium risk bucket to the high-risk bucket when there is a significant dip and so on.

The low, medium, and high-risk buckets can always be constructed with simple index funds and short-term debt funds. However, the stakes are higher after retirement, so hybrid fund options can also be considered for the equity part.

  • Equity part: Direct equity, Nifty or Sensex index funds Balanced advantage fund or dynamic asset allocation funds or aggressive hybrid funds can be used. These can even include funds that swing from equity-like to debt-like in terms of taxation. For fund, recommendations see: Handpicked List of Mutual Funds July-Sep 2021 (PlumbLine)
  • Fixed income: PPF,  fixed deposits, a mix of money market funds, arbitrage funds, gilts funds, corporate bond funds or even a conservative hybrid fund like Parag Parikh Conservative Hybrid Fund.

Lower volatility should be the main parameter for the low-risk bucket. So a dynamic asset allocation or balanced advantage fund can dominate the equity of low or even medium-risk buckets. Fixed deposits, PPF and short-term funds can dominate the debt portion of the low-risk bucket.

There are multiple ways to mix and match equity and fixed income instruments. The key to doing this well depends on the retirees’ experience and, more importantly, appreciation of visible and invisible risks.

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