You worked hard during your working years, saved money every month, and invested it diligently in a monthly . As a result, you built a well-deserved retirement fund. Now that you have retired, it is time to enjoy the fruits of your efforts. You decide to make monthly withdrawals from your retirement fund and let the balance amount remain invested so that it can continue to grow.
However, due to ongoing geopolitical wars and trade wars, the stock market has become volatile with a downward bias. In the last 1 month, the Nifty 50 Index has corrected by more than 8% due to the ongoing US/Israel – Iran War and the uncertainty surrounding it. You fear that if the market moves down rapidly, a big chunk of your fund will get eroded, and run the risk of exhausting it much before than scheduled.
In this article, we will understand how to invest your retirement fund so you can make monthly withdrawals for your regular expenses, while letting the remaining amount stay invested and grow without stressing you out.
How to design your retirement withdrawal strategy?
People take various approaches to deploy their retirement corpus and start making monthly withdrawals from it. Some people shift their entire retirement corpus into fixed-income instruments and then make monthly withdrawals. From the corpus safety perspective, it is a sound strategy. However, the corpus may grow at a slow rate. The growth rate may or may not beat the inflation rate, and may not be tax-efficient.
Some people are at the other extreme end. They keep their retirement corpus in equities itself and start making monthly withdrawals from it. When markets are doing well, it may look like a sound strategy. However, if markets turn volatile and fall, as is currently happening due to the US-Iran War and crude oil prices spiking, it can erode a decent part of your retirement corpus.
If the stock market falls in the first couple of years of your retirement, at a lower mutual fund NAV, you will end up redeeming a far higher number of units than you would have had the markets been stable or rising. In such a scenario, you run the risk of outliving your retirement corpus. At that stage, relying on others for financial support will not be a good idea.
So, then what should be your strategy to deploy your retirement corpus? At the start of your retirement, should you transfer the entire corpus to fixed-income instruments or continue holding it in equities or take some other approach?
Three bucket strategy
Some financial experts recommend neither of the two strategies above. They recommend a completely different strategy that takes the best of the above two strategies. The three-bucket strategy involves splitting your retirement corpus into three different buckets as follows.
Safety bucket
In the safety bucket, you can maintain funds equal to one to three years of expenses. You can keep this money in a savings account or a liquid fund. The savings account funds are accessible immediately via UPI, debit card, ATM withdrawals, fund transfers, etc.
Many liquid funds also offer instant liquidity through ‘insta-redemption’ or any other name they may refer it to. As per this facility, the investor is usually allowed to redeem up to Rs. 50,000 or 90% of the fund value, whichever is lower. The redemption limit is usually per day per investor per scheme. The redemption money is transferred to the investor’s bank account within 30 minutes.
The money in the safety bucket can be replenished from the savings bucket on an annual basis or as needed. At the start of every year, you can review the balance in the safety bucket. Based on the available balance and estimated spends for the entire year, you can transfer funds from the savings bucket to the safety bucket.
The money maintained in the safety bucket can be used for regular monthly expenses, medical expenses, travel, gifting, house repairs, donations, etc. The primary aim of keeping money in the safety bucket is liquidity and easy accessibility. The returns will be low, which is okay.
Savings bucket
In the savings bucket, you can keep money that can stay invested for three to seven years. You can keep this money in hybrid , such as balanced hybrid funds, dynamic asset allocation funds, or multi-asset allocation funds. The savings bucket offers a blend of stability and growth. It will grow your money at a steady rate.
The safety bucket may grow your money at a slower rate than pure equity funds can offer. But, at the same time, it helps you avoid the high volatility and steep falls that equity can experience.
The money maintained in the savings bucket can be used to replenish the safety bucket annually or as required in between. It can also be used for one-time lump-sum expenses, such as a home renovation, a lavish domestic vacation or an international vacation, or celebrating milestones like a 75th birthday or a 50th marriage anniversary.
As and when required, the money needed in the savings bucket can be replenished from the wealth bucket.
Wealth bucket
After putting in place the safety and the savings bucket, the remaining money can be maintained in the wealth bucket. The bucket should hold money that can remain invested for more than seven years. You can keep this money in equity mutual fund schemes, such as market capitalisation funds (large-, mid-, and small-cap funds), or a combination of these (flexi- or multi-cap funds). A small portion of the portfolio can be invested in sectoral, thematic, international, smart-beta funds, etc.
The wealth bucket is for growing your money. As the money remains invested for the long term, it can benefit from the power of compounding. There can be volatility and sharp corrections in the short-term. However, that should not bother you as an investor, as there is no immediate redemption pressure on you. During such periods, you can stay calm and wait for the market to bottom out, turn around, recover, and get back to growth once again.
The money maintained in the wealth bucket can be used to replenish the savings bucket annually or as required in between. You can use the money in the wealth bucket for legacy planning.
Why should you adopt three bucket strategy for retirement planning?
The three bucket retirement strategy addresses all 3 requirements of any investor:
- Safety (regular monthly expenses),
- Savings (fund that grows steadily, acts as backup, and replenishes the safety bucket regularly), and
- Growth (creates wealth, replenishes the savings bucket regularly, and can leave behind a legacy)
The strategy provides a good balance between meeting immediate requirements, maintaining a near-term cushion, and growing wealth in the long term. As the immediate requirements are being met from the safety bucket, during volatile times and major market corrections, the investor need not panic. You can stay calm and wait for the market to turn around.
The strategy provides flexibility to adjust the amount of money to be maintained in each bucket based on the investor’s needs. The safety bucket can be replenished from the savings bucket, and the savings bucket can be replenished from the wealth bucket annually or as required.
With the flexibility provided by the three-bucket strategy, you are well in control of your retirement corpus. Whether the markets are rising or falling, you can stay calm and enjoy your golden years stress-free.