The quest for secure retirement income
/Why the four-bucket method could be the holy grail.
According to legend, the ‘holy grail’ was a magical cup imbued with miraculous powers that provide happiness, eternal youth or sustenance in infinite abundance.
That perfect product pitch resulted in an awful lot of fictional knights going on misguided adventures that ultimately led to unfortunate conclusions. In hindsight, the ‘holy grail’ marketing department perhaps over-sold the concept – at the very least, there was poor risk disclosure.
Some source materials credit three knights with finding the magical cup. But most seekers, side-tracked by events, ultimately lost sight of the main goal.
Similarly, for many, the long-held promise of the Australian superannuation system as the deliverer of sustainable retirement income is fading from view, in an era of low- interest rates and rising risks.
But the problem could be that many investors are looking in the wrong places.
Beyond the end of the road
Without a doubt, superannuation has taken more Australians further down the road to a comfortable retirement than most would have achieved alone.
However, the contribution-and-investment mindset that has been so successful in accumulating super assets – now about A$3 trillion – could prove counterproductive as retiring members look to transform those savings into income for life.
Faced with a finite pool of assets, uncertain investment returns, and an unknown number of years to fund, retirees often take a conservative approach to ward off their greatest worry: running out of money.
In fact, our research has shown that 61% of retirees fear running out of money more than death itself1.
The bucket strategy
The ‘bucket strategy’ has been a common way to help deal with this risk. It works by managing the selling of assets at retirement, balancing the need for steady income and capital growth.
A typical bucket strategy allocates a certain proportion of savings to cover short, medium and long-term needs. Investments are apportioned to cash, fixed income and equities, according to your individual risk tolerance and time horizon.
Your financial adviser might suggest this strategy as a proven tool to take the focus away from market volatility and leave you feeling comfortable about your retirement plans.
Enhancing the ‘bucket strategy’
But when it comes to delivering sound retirement outcomes, the current low-interest rate environment (compounded by the COVID-19 crisis) presents some challenges to the bucket strategy. Effectively, the short-term bucket may struggle to deliver the returns needed to fund retirees’ short-term cashflow requirements.
The ‘holy grail’ of retirement income, or at least an enhanced outcome in the current environment, is likely to be found in a fourth bucket that increases your growth allocation. It also serves to mitigate unique retirement risks – including longevity, sequencing and behavioural risks – through a protected equity strategy.
As an example, a protected equity strategy may provide you with exposure to growth via market-linked returns (such as an index) – with in-built protection from losses (floor), providing exposure to market growth up to a selected cap.
Let’s walk through an example of a standard three-bucket approach:
15% in bucket 1 (cash)
25% in bucket 2 (fixed income)
60% in bucket 3 (equities).
An enhanced approach using four buckets might be:
5% in bucket 1 (cash)
10% in bucket 2 (fixed income)
20% in bucket 3 (a retirement-specific protected equity solution)
65% in bucket 4 (equities).
This equates to 85% in equities (buckets 3 and 4), 10% in fixed income and 5% in cash.
This method has the potential to increase returns due to the increased exposure to equities, while also providing less reliance on lower-yielding assets such as cash and fixed income. Also, due to the protective floor, the potential losses that could occur in bucket 3 are limited.
If you’re interested in applying an enhanced bucket strategy to your retirement plans, chat to your financial adviser today.
1 Allianz Life, Reclaiming The Future Study, 2010.
