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The three-bucket approach to retirement investing

Written and accurate as at: Dec 10, 2016 Current Stats & Facts

When devising a retirement plan, there are several different strategies that a financial adviser can employ to make sure that you have enough to meet your retirement lifestyle needs. This may or may not include relying in part or wholly on other sources of income including social security entitlements such as the Age Pension at some stage.

One such strategy is the ‘bucket’ approach. This involves dividing assets into different short, medium, and long-term buckets to leverage the relationship between risk versus return (pegged to your specific time frames and cashflow requirements) whilst still applying the principle of diversification and risk profiling within your investment portfolio.

Essentially, the bucket approach involves segmenting your investments into two or more buckets (in retirement these might be held in your account-based pension):

  • A ‘cash bucket’ with cash investments to fund your short-term retirement lifestyle (expected lump sum withdrawals and regular pension payments) over the next one to two years;
  • A ‘stable bucket’ with other income generating investments (e.g. fixed interest) to help account for an additional one to two years of retirement income; and
  • A ‘growth bucket’ with the remaining balance held with more risk-associated investments (e.g. property and shares) in accordance with your risk profile for longer term growth.

The cash and stable buckets are then replenished periodically, with enough funds to cover the next two to four years of expected lump sum withdrawals and regular pension payments. Depending on the strategy approach taken, this could occur:

  • At the end of the two or four-year period, or earlier if the cash and stable buckets are depleted sooner;
  • Each year when your financial situation is reviewed; or
  • Tactically, where the growth bucket cumulative returns have exceeded certain benchmarks, or the growth bucket appears overvalued.

When using the bucket approach, your financial adviser works with you to find an optimal level of investment risk you are willing to take to achieve your short, medium, and long-term financial goals and objectives, then matches this to an appropriate investment portfolio.

For example, if you are willing to take additional risk you may find that you are more heavily weighted towards shares and property assets, comparatively if you are less risk-adverse then you may hold more of your wealth in cash, term deposit, bond, and annuity assets – a range of other considerations may also play an important role in establishing these same parameters.

Things to consider

Life expectancy in Australia has improved dramatically for both men and women in the last century due to our increased awareness and understanding of the factors that influence our life span such as genetics, health care, hygiene, diet and nutrition, exercise, and lifestyle.

In Australia, if you were aged 65 in 2013-15* then you could expect to live for another 19.5 years (male, to age 84.5 years) and 22.3 years (female, to age 87.3 years).

Past historical returns, although not indicative of future returns, have shown that growth assets such as shares and property are on average likely to outperform purely cash and fixed interest based investments over the long-term (the sort of timeframe that normally applies to an account-based pension given current life expectancies). In the short-term, however, the share and property market can be volatile, as anyone who has endured the global financial crisis would know.

The logic of the bucket approach is that regardless of the short-term performance of the investment pool your expected lump sum withdrawals and regular pension payments can continue from the cash and stable buckets without the forced sale of more risk-associated assets in the growth bucket at unfavourable prices.

This simple example*^ may help to illustrate the effects of potentially being too conservative with your portfolio weighting as you not only approach, but also start to enjoy your retirement years.

Matthew and Mary just reached age 65 and have decided that the time has come to hang up their boots. A combination of concessional and non-concessional contributions throughout their working life, as well as investment growth, has meant that they have managed to accumulate $640,000 in total account-based pension wealth and now wish to draw down a combined $59,160 per annum in regular income payments, adjusted each year to offset inflation, to fund their comfortable# retirement lifestyle. If they were both invested in:

  • Cash portfolios, earning 2.9% per annum return before costs, they may find their annual income falling by 5% below their income requirements at age 75 and their total account-based pension wealth reaching zero at age 76; or
  • Balanced portfolios, earning 8.0% per annum return before costs, they may find their annual income falling by 5% below their income requirements at age 79 and their total account-based pension wealth reaching zero at age 80.

What you may have already noticed is that despite the Balanced portfolio potentially having the capacity to stretch the account-based pension balances further than the Cash portfolios there is still a shortfall in the income required to fund Matthew and Mary’s retirement lifestyle to their respective life expectancies.

We are not advocating you step outside of your risk tolerance zone by weighting your portfolio beyond what you are comfortable with; however, you should consider options to maximise your retirement ‘nest egg’ so that you have adequate income to meet your life expectancy, particularly given the tightening of Age Pension entitlements moving forward. This may include strategies such as the bucket approach, planning for your retirement much earlier, making additional contributions to build your superannuation, as well as possibly rethinking your retirement lifestyle expectations.

Another potential strategy that can make a significant difference is working an additional couple of years or undertaking part-time employment.

As it stands, the average superannuation balance#^ for a 60-65-year-old Australian is $292,510 (males) and $138,154 (females) and roughly 80%#* of all Australians aged 65 years and over rely, at least in part, on the Age Pension.

It is important to review your personal finances, the investment environment, and available options to maximize your financial position on a regular basis.



*Australian Government, Australian Bureau of Statistics. Life Tables, States, Territories and Australia, 2013-2015. Retrieved from: http://www.abs.gov.au/AUSSTATS/abs@.nsf/DetailsPage/3302.0.55.0012013-2015?OpenDocument

*^As this is information only, the calculations above have not included potential Age Pension entitlements, other income generating investments outside of superannuation, nor has there been considerations towards investments available or fees associated with specific account-based pensions; these, along with consideration of your own financial goals and objectives, are important when devising an appropriate retirement plan with your professional financial adviser.

#ASFA Retirement Standard. Retrieved from: http://www.superannuation.asn.au/resources/retirement-standard

#^ASFA. Superannuation Statistics, September 2016. Retrieved from: https://www.superannuation.asn.au/resources/superannuation-statistics

#*Australian Government, Australian Institute of Health & Welfare. Australia’s Welfare 2013. Retrieved from: http://www.aihw.gov.au/WorkArea/DownloadAsset.aspx?id=60129544075

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