Arthgyaan

Supporting everyone's personal finance journey

How to plan for retirement using the bucket approach?

Use the bucket theory of asset allocation to create a simple and stress-free retirement portfolio.

How to plan for retirement using the bucket approach?


Posted on 21 Jun 2021
Author: Sayan Sircar
6 mins read
Get new post notifications on WhatsApp!

Use the bucket theory of asset allocation to create a simple and stress-free retirement portfolio.

Bucket theory for retirement

šŸ“š Topics covered:

Introduction

There are a lot of theories and complexities around retirement portfolio construction that involves complexities around debt to equity allocation, inflation assumptions and safe withdrawal rates (SWR). We have tackled some of these in a simplified manner in this post on retirement portfolio construction using Excel.

This post simplifies the problem further for someone ready to enter retirement by creating just three buckets of cash, bonds and equity for the construction of a retirement portfolio. This post is targeted at someone entering retirement anytime between today to a year from now. Anyone with retirement expected to start more than 1 year from now should simply follow this post instead. Please note that at all times, there should be adequate emergency fund, health insurance and personal accident insurance over and above the retirement portfolio. Ensure that the yearly budget includes health insurance premium. Once the buckets have been created then periodic review and rebalance must be done to ensure that risk is being managed. The Rebalance column in the Excel calculator will show how rebalancing is to be done. See this detailed post on how and when to do rebalancing.

Bucket composition

The amounts allocated to each bucket is calculated on the basis of appropriate asset allocation for each year of retirement and each year has its own glide-path and plan for rebalancing. The aggregate view for each year for cash, income and growth assets is summed up to create the buckets.

Recent articles:
1 / 3
<p>A quick retirement calculation for a reader query who has a good amount of corpus already saved for retirement.</p>
2 / 3
<p>This article explains the PFRDA announcement about a new default scheme under NPS Tier II for government employee subscribers.</p>
3 / 3
<p>As per SEBI rules, mutual fund investors must have nominees in their folios by 1st October 2023 or explicitly opt out. Otherwise they will face restrictions in selling units.</p>

Join the Arthgyaan WhatsApp community: You can stay updated on our latest content and learn about our webinars. Our community is fully private so that no one, other than the admin, can see your name or number. Also, we will not spam you.

Bucket 1: Cash

The purpose of this bucket will be to hold living expenses for the next 5 years. These living expenses are inflation-adjusted and will be based on the yearly expenses in the first year of retirement. Any interest payments, rents, pension income or dividends (all post-tax values) should be excluded from the value of the yearly expenses before finding out the amount to be saved in this bucket. Over time, these income sources are expected to grow at the after tax cost of debt.

For example, if living expenses in the first year of retirement is 60,000/month (7.2 lakhs/year) and post-tax pension, rent and interest payments of 3.2 lakhs/year are expected to be received yearly then we need to keep 29 lakhs in this bucket. Keep the money in big banks like SBI/HDFC/ICICI that are considered ā€œtoo-big-to-failā€ by RBI. This bucket, will also contain the emergency fund equal to 12 months of living expenses (7.2 lakhs in the example). Estimation of the expenses in retirement is covered in more detail here.

The cash bucket gives the peace of mind that a 2008 style crash in the equity markets will not require a fire sale of stock portfolio to fund regular expenses.

You can use an SWP to generate regular income from the cash bucket: SIP, SWP and STP - what do they mean, which one should you choose and when?.

Bucket 2: Income assets

The purpose of this bucket is to hold assets that generate income via

  • interest payment (like government savings schemes like SCSS, Post Office MIS)
  • fixed deposits
  • coupon paying instruments like RBI Bonds
  • payments like annuities/pension

This income feeds down to bucket 1. This post has more details on the suitable debt instruments during retirement.

This bucket will have around 35-50% of the total retirement corpus.

Bucket 3: Growth assets

This bucket will have everything that is not there in buckets 1 and 2 above. This bucket exists to provide growth that beats inflation over time. This is very important given the interest rates in India have been falling in line with global trends. Going forward, as India becomes more and more developed as an economy, interest rates are expected to remain low and investing in equity remains the only way to beat inflation. Choose equity funds from this framework. High dividend-paying stocks can be also included here however their price appreciation will not be as much as growth stocks.

What should be the asset allocation between the buckets?

Bucket-wise Asset Allocation in Retirement

We have calculated an optimal allocation of risky and lower-risk assets in this detailed post: How to construct buckets for your retirement portfolio?

Rebalancing between various buckets

In retirement, you do not need a salary but you need money for monthly expenses which will always come from Bucket 1. Instead of running an SWP (Systematic Withdrawal from mutual fund) from any of your buckets, you should withdraw as and when required.

A regular review process will need to be conducted every year to move money between the three buckets as per requirement. This is due to market movements in debt and equity funds as well as changing interest rates. Each rebalancing is handled first for each year in retirement and summed up to get the aggregate change at the bucket level.

If an asset is sold that gives rent or interest, it will impact bucket 1 value. So in that case, allocate like this: Asset value > Cash, Cash > other buckets. For example, when land is sold then add the post-tax sale value to cash and set the land value to 0. Then the sheet will again show you how much to sell from Bucket 1 to move into other buckets.

Walk-through of the example

Buckets example

We give a walk-through of the worked-out example in this Excel workbook.

Assumptions

The annual expenses in the first year of retirement are assumed to be 7.2 lakhs with 7% overall inflation and equity/debt returns (after-tax) to be 11% and 4% respectively. The tax rate is assumed to be 10% (assets split between spouses to lower taxable income)

Assets table

Here all the existing assets (total 1.5 crores) are entered along with their market value, interest rate and applicable tax rate. Please note that

  • Rate for PPF is market-linked and will change
  • Rates for government savings schemes and FD will be different at the time of renewal
  • Debt and equity MFs do not give any guaranteed returns
  • Stock dividends are not guaranteed
  • The house gives rental income but needs to be sold to invest in equities

Results section

Retirement portfolio

This shows the current value in each of the three buckets (Have column). The ā€œShould Beā€ column shows the value which should be as per the right asset allocation. The Rebalance column shows the amounts to be moved in and out of each bucket to maintain the correct asset allocation. After that, the ā€œRetirement Should be Funded forā€ value shows how many years the corpus is expected to last. There is another alternative in constructing this portfolio using a pension plan. This post deals with retirement with pension.

What's next? You can join the Arthgyaan WhatsApp community

You can stay updated on our latest content and learn about our webinars. Our community is fully private so that no one, other than the admin, can see your name or number. Also, we will not spam you.

If you liked this article, please leave us a rating

The following button will take you to Trustpilot:

Discover an article from the archives

Worked out case studies for goal-based investing

Previous and next articles:

<p>Young earners can follow these basic steps to start saving and investing.</p>
Budgeting
Young earner series: DOs and DON'Ts

Young earners can follow these basic steps to start saving and investing.

Published: 20 June 2021

6 MIN READ


<p>This post shows how to use the bucket theory of asset allocation to create your FIRE portfolio.</p>
Retirement FIRE
How to plan for FIRE using the bucket approach?

This post shows how to use the bucket theory of asset allocation to create your FIRE portfolio.

Published: 22 June 2021

3 MIN READ


Latest articles:

<p>This article shows a handy ready reckoner for home loan EMI amounts for all tenures and interest rates along with the amount of principal and interest to be paid.</p>
House Purchase
How much EMI do I have to pay for my home loan?

This article shows a handy ready reckoner for home loan EMI amounts for all tenures and interest rates along with the amount of principal and interest to be paid.

Published: 29 September 2023

1 MIN READ


<p>A quick retirement calculation for a reader query who has a good amount of corpus already saved for retirement.</p>
Retirement Reader Questions
How much money does this 39 year old investor need to invest per month to retire at 58?

A quick retirement calculation for a reader query who has a good amount of corpus already saved for retirement.

Published: 27 September 2023

7 MIN READ


Topics you will like:

Asset Allocation (20) Basics (8) Behaviour (10) Budgeting (11) Calculator (17) Case Study (6) Children (12) Choosing Investments (38) FAQ (6) FIRE (13) Gold (11) Health Insurance (4) House Purchase (17) Insurance (15) International Investing (10) Life Stages (2) Loans (9) Market Movements (13) Mutual Funds (29) NPS (6) NRI (13) News (9) Pension (8) Portfolio Construction (46) Portfolio Review (27) Reader Questions (6) Real Estate (6) Retirement (36) Review (12) Risk (6) Safe Withdrawal Rate (5) Set Goals (27) Step by step (14) Tax (37)

Next steps:

1. Email me with any questions.

2. Use our goal-based investing template to prepare a financial plan for yourself
OR
use this quick and fast online calculator to find out the SIP amount and asset allocation for your goals.

Don't forget to share this article on WhatsApp or Twitter or post this to Facebook.

Discuss this post with us via Facebook or get regular bite-sized updates on Twitter.

More posts...

Disclaimer: Content on this site is for educational purpose only and is not financial advice. Nothing on this site should be construed as an offer or recommendation to buy/sell any financial product or service. Please consult a registered investment advisor before making any investments.

This post titled How to plan for retirement using the bucket approach? first appeared on 21 Jun 2021 at https://arthgyaan.com


We are currently at 299 posts and growing fast. Search this site:
Copyright Ā© 2021-2023 Arthgyaan.com. All rights reserved.