If you are retired, or within three years of retirement, then you should be using a two bucket investment strategy for retirement.
Smart investors who use this investment strategy for retirement can sleep better at night without having to worry about the next share market collapse, because they have around three years of withdrawals or pension payments in a ‘cash’ bucket which has no exposure to more volatile asset classes like shares and property.
The second bucket is where all the action happens. Typically, you will have around 70-80% of your superannuation investments exposed to quality growth investments providing both income and capital growth.
This year, many superannuation funds have experienced above average returns, particularly from Australian shares, resulting in a healthy looking ‘big’ bucket for those investors using a two-bucket investment strategy for retirement.
The question is, when do you top up your ‘cash’ bucket so that you maintain around three years of withdrawals in a safe and low risk investment?
The concept of having a two-bucket investment strategy is designed so you only draw profits from your big bucket to top up your cash bucket. The worst case scenario is when share markets produce negative returns for three years or more, preventing you from topping up your cash bucket and then having to dip into your big bucket for your ongoing income needs.
This results in even greater losses because you will be selling investments that have already fallen in value.
Retirees who have used a two-bucket investment approach over the last five years and through the Global Financial Crisis (GFC) would have experienced less in actual losses as their cash bucket would have had no exposure to those volatile assets. But, just as those who lost faith and moved all or most of their big bucket into cash during the GFC, the temptation now is to move your cash bucket back into the big bucket in a hope of making quick returns while the share markets are performing so strongly.
It is also tempting to run down the cash bucket and leave the big bucket exposed to the current strong returns, while ignoring the need to top up your cash bucket to maintain at least three years of income withdrawals.
If your big bucket is showing healthy returns over the last six to 12 months and your cash bucket has less than three years of income then it is time for you to consider topping up your cash bucket. Resist the temptation of ‘letting it ride’ while the market is up. You will never pick the top or bottom of the market. Take your profits while you can and be content in the knowledge that any profit is better than taking a loss.
This article first appeared on SuperBiz.
Rob Bourne has more than 35 years’ experience as a financial adviser.