What If You Retire or Need Income During a Bear Market? — Part 2
This is the second segment of a multi-part series aimed at educating investors on how to better plan for their retirement years.
Key Takeaways
Bucketed portfolios help you to visualise where you should start your withdrawals and segregates your investments into the categories that you can and cannot touch but as a system overall, it’s sub-optimal.
This is because you will tend to overallocate to the safest bucket, at the cost of not keeping up with inflation and rising spending needs over the years.
A total return approach like our pension-type portfolios aggregates the buckets, aims to optimise the long-term risk and return of the investment, and ensures the longevity and sustainability of your assets.
Retirement is not the end of the road, it's the beginning of the open highway
— Anon
In our previous article: What If You Retire or Need Income During a Bear Market? — Part 1, we showed our typical retirement “pension” plan portfolio and how important the asset allocation was — both in ensuring the long-term sustainability of the portfolio to generate returns as well as the ability to fund withdrawals during periods of crisis.
When we invest and allocate for our clients in such a portfolio, it is not immediately visible nor apparent which investments or funds fulfil what purpose. A simple way to visualise the retirement portfolio is to think about your money in buckets.
Bucketed portfolios are aimed at providing spending resources during your ‘decumulation’ periods, usually in retirement. Typically composed of three buckets, they are arranged by time horizon and investment type as illustrated in the diagram below.
However, in the same way that setting multiple bank accounts for various spending and expense activities may not be the most efficient, bucketing your assets may not be all that rational. “Rational” investors assess all of their investments as a whole and only care about maximising long-term returns for the appropriate level of risk taken.
In reality, we are emotional and invest based on how we feel. Typically, we err on the side of safety and as a result, bucketing comes with a cost. Investors who visualise their assets in buckets usually have larger allocations to cash than is necessary by considerations of expected return and risk alone. Given the insidious and often hidden bite of inflation, this comes at a cost.
Nonetheless, segregating or bucketing your money helps to frame your assets into distinct mental accounts and can help you rationalise which accounts you take from first, and which accounts are meant to be left alone and untouched — even in a market downturn. Bucketing helps to solve the behavioural finance problem and can be an effective tool ensure you are setting aside enough for both short-term and long-term needs.
Getting Over Behavioural Biases
To understand the behavioural advantage of a portfolio in various buckets, consider a year like 2022 when the prices of both bonds and stocks declined. Someone without a cash mental account who needed money for expenses and spending probably faced a couple of difficult choices in that year.
One of these difficult decisions would probably be selling the invested bonds and or stocks at lower prices than what it was in 2021. Doing so registers as a mental loss, bringing about hindsight bias and exacting the disturbing feeling of regret. The thought of “Why didn’t I sell earlier? I should have known that rising rates would cause market volatility! Now I have no choice but to take a loss.”
Another difficult decision involves selling less than what was required; which could circumvent some feelings of regret but could result in needing to spend less than what you had planned. Perhaps this means foregoing the trip that you really wanted to go on, and even forsaking other purchases like a new oven for the house or an upgrade for your car.
How We Incorporate This System In a Fuss-free Way
There is a way to enjoy the advantages of this segregation without needing to manually execute the buckets yourself. In our retirement “pension” portfolios, the buckets are already built in and integrated. Using the sample portfolio shown in our first article, you can use the framework shown below as an example.
Don’t Try to Predict What Will Happen,
But Plan For What Can Happen
As such, we always come back to the importance of asset allocation. There is a purpose for every fund chosen in the investment. When broken down into more granular detail, we come to understand what the reasons are for the apportionment. When put together properly, we then get an aggregated idea of the portfolio risk and return.
So, you don’t need to bear the cost for the behavioural benefits of bucket portfolios by managing it yourself. We can help you assemble and piece it together in a way that maximises your investment output while helping you understand what each and every component is meant to do. Often you may find that sustainable solutions are not solely about returns, but how the risk and longevity is managed. Knowing more will also help you stay seated during future market downturns and uncertainty — events which are bound to happen sooner or later.
To find out more, schedule a meeting with your advisor or contact us.
