This article explains how retirees should allocate their investments between equity, debt and cash buckets for their post-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
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.
What is the basis of asset allocation in retirement?
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We will use the āMediumā 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. You can also implement as per our model portfolios below:
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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:
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. Letās 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%.
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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This post titled How to construct buckets for your retirement portfolio? first appeared on 08 Mar 2023 at https://arthgyaan.com
