Today, the average 55-year-old Canadian can expect to live to the age of 84, a gain of 24.6 years since 1926. While that is a good reason to celebrate, it also means that Canadians are now spending nearly as much time in retirement as they do in their working lives. This poses a challenge to retirement savings, which have to last longer than ever before. A well-structured approach to portfolio construction can help sustain retirement income over the long run and bring peace of mind. I would like to introduce a retirement income planning approach we refer to as bucket portfolios. “Bucketing” means dividing a portfolio into three main investment time horizons: a long-term bucket, a medium-term bucket and a short-term bucket. The goal is to insulate the long-term bucket from near term cash flow needs, allowing the equity portion of the portfolio to remain invested longer and grow over time. Annual retirement income is drawn from the short-term bucket, which holds several years in reserve and is topped up from the medium-term bucket. The top-up process is tailored to the investor’s unique circumstances and general market conditions.

 

How they are structured

An individual’s initial wealth determines the size and holdings of each bucket by evaluating one’s income requirements, the risk and return characteristics of the individual asset classes and cash flow needs.

Long-term – Growth (Years 10+)

The long-term bucket holds growth-oriented equity funds, which are more volatile but offer higher potential for capital growth to sustain the portfolio for the later years of retirement.

Medium-term – Buffer (Years 6-10)

The medium bucket holds income-generating investments. This would include low volatility equities for stable capital gains. This bucket serves as a buffer between the cash bucket and the long-term growth bucket.

Short-term – Income (Years 1-5)

The short-term bucket holds cash and cash-like short-term investments for income withdrawals and emergency funds. It also helps to reduce the impact of short-term market volatility on the portfolio.

Step 1:

Determine how much annual cash flow you will need from your retirement portfolio. Estimate your annual expenses in retirement, and from these deduct other sources of cash flow you’ll have (e.g., pensions and guaranteed income). The shortfall, if any, is the annual cash flow you’ll need from your bucket portfolio.

Step 2:

Ask yourself how many years of cash flow you want to have readily accessible, including emergency funds. The short-term bucket is not meant to grow. It is designed to provide you with a higher degree of certainty that your cash flow needs will be met for the next few years (typically 3-5 years of cash flow).

Step 3:

Create a “buffer” between short-term cash flow needs and long-term growth investments. A portfolio’s longer-term sustainability could be hurt by selling growth-oriented investments on short notice. The medium-term bucket allows your growth bucket to remain invested during a downturn in the market. It holds more conservative investments than the growth bucket and can be used to top up the short-term bucket if needed (usually 3 – 7 years of cash flow)

Step 4:

Invest the remainder in growth-oriented securities. The long-term growth bucket represents the remainder of your portfolio and is comprised primarily of equities. It will vary in size depending on the size of your total portfolio and the number of years of income allocated to the short- and medium-term buckets.

 

To learn more about implementing bucket portfolios within your retirement plan, RSVP to our retirement income planning seminar, What's your picture-perfect retirement?