The content of the last two chapters should be encouraging for any investor or retiree. If we invest in a broad, market-based portfolio in the right allocation, and stay invested for an adequate time period then we will get positive returns.
However, one problem remains: positive returns are not always enough returns. For example, we expect a portfolio to give us 5% return per annum over the investment time horizon. Instead, the market returns 3%. This leaves us with a nest egg that is smaller than planned.
To address this issue, our team at Providend made an enhancement to our RetireWell™ methodology which we call the Reserve Bucket—which is patent pending. It is essentially a seventh bucket that is invested in a conservative portfolio. If the return in any of the buckets fall short of the planned required return, we can tap on this additional resource.
Bigger is Not Always Better
The challenge with such a bucket is determining just how much money should be set aside. On one hand, setting aside more money reduces the risk that their plan will fall short. On the other hand, an additional Reserve Bucket (patent pending) means either having to accumulate longer before determining that they have enough to retire or planning to spend less in retirement in order set aside this safety net.
With a bigger Reserve Bucket (patent pending), more resources will be required for their plan. This is a problem because, at the end of the day, it is a backup bucket which we hope they will not have to use. If they end their retirement journey with too much left over, they would have underspent and did not optimise the enjoyment of the fruit of their labour.
Striking a Balance
In the end, we decided to crunch the numbers and find out which of the RetireWell™ Buckets run the risk of missing their targets given their investment time horizons and by how much. We then worked backwards to figure out how much a retiree should set aside in addition to the first six buckets at the start of their retirement such that when those buckets may potentially need a top-up, the right amount of money would be waiting and ready. If they never need a top-up, then the retiree would become free to spend from the Reserve Bucket (patent pending).
We determined that even though we use more conservative portfolios for the shorter time horizons of Buckets two and three, the shorter investment periods mean there remains a small, though non-negligible, chance that they may fall short of their expected returns. The Reserve Bucket (patent pending) is designed to adequately supplement these potential gaps.
Such a bucket is most useful in cases where a retiree cannot afford to adjust their spending downward when they encounter an unlucky sequence of returns in the first 15 years of their retirement. That said, maintaining flexibility and openness to discuss and reduce one’s spending adds an additional layer of safety.
The writer, Christopher Tan, is Chief Executive Officer of Providend, Southeast Asia’s first fee-only wealth advisory firm and author of the book “Money Wisdom: Simple Truths for Financial Wellness“.
Here are the links to the RetireWell™ eBook chapters:
- Part 1: Drawing Down Retirement Money
- Part 2: A Tale of Two Retirees and Their Fortunes
- Part 3: Ensuring a “Safe Retirement Income Floor”
- Part 4: Investment Philosophy for a Retiree Client
- Part 5: Stock Markets Always Rise Over the Long Term
- Part 7: Capturing Returns Effectively
- Epilogue 1: Purpose-Driven Retirement Planning
- Epilogue 2: Retirement – It’s About the Kind of Life You Want to Lead
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