What is the concept of the bucket portfolio for retirement?

The concept of the 3-bucket retirement portfolio creates three risk-based asset pools or buckets out of the retirement portfolio: Bucket 1: cash for short-term expenses (3-5 years) and emergency fund (12 months of expenses); Bucket 2: debt assets for portfolio stability and income Bucket; 3: inflation-beating assets like equity MF and direct equity stocks.

How to review the retirement portfolio every year once buckets are created?

To review the retirement portfolio every year, you need to revisit the entire retirement portfolio since, in the X-Axis, you need to move one place to the left. The asset allocation changes and therefore portfolio will need to be rebalanced by selling assets in the category which has excess and buying that category which has more to bring the allocation to the target figure.

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How to construct buckets for your retirement portfolio?

Q: What is the basis of asset allocation in retirement?

The basis of asset allocation in retirement is using the Medium risk profile and applying the allocation to each year in retirement. The Arthgyaan goal-based investing calculator is used to arrive at the split of equity, debt and cash buckets.

Q: What should be the split of buckets in retirement?

The split of buckets in retirement depends on several assumptions, such as equity return, debt return, and inflation rate. Based on these assumptions, the split of equity, debt, and cash is determined using the Arthgyaan goal-based investing calculator. The allocation changes every year as the X-Axis moves one place to the left, and the portfolio needs to be rebalanced accordingly.

Posted on 08 Mar 2023
Author: Sayan Sircar

Tags: Asset Allocation ; Retirement

4 mins read

This article explains how retirees should allocate their investments between equity, debt and cash buckets for their post-retirement portfolio.

How to construct buckets for your retirement portfolio?

Summary:

We cover how retirees should allocate their investments between equity, debt, and cash for their post-retirement portfolio using the 3-bucket model
The 3-bucket portfolio creates three risk-based asset pools or buckets, which are cash for short-term expenses, debt assets for stability and income, and inflation-beating assets like equity.
We explain the basis of asset allocation in retirement and how to split assets between the three buckets based on the concept of goal-based investing
Based on assumptions for equity and debt returns, and inflation rate, we use the Arthgyaan goal-based investing calculator to arrive at the split of equity, debt, and cash
At the end, we explain how to review the retirement portfolio every year and how to rebalance the portfolio to bring the allocation to the target figures

📚 Topics covered:

What is the concept of the bucket portfolio?
What is the basis of asset allocation in retirement?
What should be the split of buckets in retirement?
How to review the retirement portfolio every year?

What is the concept of the bucket portfolio?

Bucket composition

The concept of the 3-bucket retirement portfolio creates three risk-based asset pools or buckets out of the retirement portfolio:

Bucket 1: cash for short-term expenses (3-5 years) and emergency fund (12 months of expenses)
Bucket 2: debt assets for portfolio stability and income
Bucket 3: inflation-beating assets like equity MF and direct equity stocks

In this article, we will discuss how retirees can split their assets between the three buckets based on the concepts of goal-based investing for retirement.

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What is the basis of asset allocation in retirement?

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We will use the “Medium” risk profile and apply the allocation to each year in retirement. Once we do that, using the Arthgyaan goal-based investing calculator, we will arrive at the split of equity, debt and cash budgets. The theory of breaking down the expenses as per retirement years is explained here: How do you get SIP amount for retirement: Part 3.

What should be the split of buckets in retirement?

We will make the following assumptions:

3 years of expenses in the cash bucket plus one-year expenses as an emergency fund
equity return in retirement is 11% post-tax
debt return in retirement is 5% post-tax
inflation is 7%

Running the model gives us the following chart:

Bucket-wise Asset Allocation in Retirement

We can read the chart like this:

Determine how long your retirement corpus is expected to last. For most families, this figure will be the life expectancy of the younger spouse. Let’s say this figure is 40 years
Locate this figure in the X-Axis, and you can see the allocation in the Y-axis. For 40 years, the equity to debt to cash allocation is 46.10%, 46.93% and 6.97%.

Once the asset allocation is determined, you can choose investments in each bucket per this guide: How to plan for retirement using the bucket approach?

How to review the retirement portfolio every year?

The process explained above is accurate as of today. A year later, you need to revisit the entire retirement portfolio since, in the X-Axis, you need to move one place to the left. In our example, the portfolio above, the passing of one year means 39 years are left. The asset allocation changes to a more conservative value of 45.75%, 47.13%, and 7.12%. The portfolio will need to be rebalanced by selling assets in the category which has excess and buying that category which has more to bring the allocation to the target figure.

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