The latest fall in share prices close to the 10-year anniversary of the global financial crisis (GFC) is likely to prompt more retirees and near-retirees to think about creating a volatility-and-downturn cash bucket.
This is a straightforward strategy intended to reduce the possibility of retirees – particularly those with many years of retirement ahead – having to sell investments at depressed prices to maintain their income in the event of an extended future downturn .
What is a volatility-and-downturn cash bucket?
Retirees and investors approaching retirement often set aside about two to three years of living expenses if possible in a volatility-and-downturn cash bucket. This provides a buffer against being forced to sell assets at the wrong time, which may cut the expected longevity of a portfolio and its ability to produce enough future growth.
In a recent commentary, actuaries Rice Warner emphasises how disciplined investor behaviour is critical to handling a sharp fall in share prices and how a cash bucket can assist them to remain disciplined.
There is typically a close link to market behaviour and investor behaviour. (Regular Smart Investing readers may have read our past discussions of these buckets.)
“The behaviour of stock markets is unpredictable as sentiment big part in short-term price movements,” Rice Warner comments. “When people are upbeat about the economy, prices often rise exuberantly; when the market turns down significantly, it is usually fast and without notice.
“So, while we can say that investment markets,” Rice Warner adds, “follow a cyclical pattern, no one can predict when the market will rise or fall. We also know that markets usually recover their losses over time, sometimes quite quickly.”
And as the commentary says, the impact of a market downturn could be magnified for investors who “lock in losses by moving into more defensive strategies [such as switching to all-cash portfolios] at an inopportune time”.
When and how can I create a cash bucket?
Investors often begin to build-up a cash bucket or buffer in their last few years before their planned retirement. For instance, some investors direct a proportion of their super contributions from their last few years in the workforce into a cash bucket within their super funds.
Other opportunities may arise to create a cash bucket including, say, an inheritance or the sale of an investment property. Some investors will simply increase the asset allocation to cash in their super funds – perhaps when periodically rebalancing their portfolios.
How big should I make my cash bucket?
While investors often set aside two to three years of living expenses in their volatility-and-downturn bucket, the size of the buffer and how it is built-up will depend on such personal circumstances as the size of an individual’s retirement savings, age, investment timeframe and perhaps professional advice. When determining the size of your cash bucket, keep the age pension in mind if applicable.
How can I top-up my cash bucket?
Some investors direct a proportion of unspent income from their main diversified portfolio, such as a balanced or growth super fund, to top-up their cash bucket from time to time – particularly during stronger-performing years. And proceeds from regular rebalancing of an investor’s main diversified portfolio can provide top-up money.
Please contact us on Ph 02 9899 9369 if you would like to discuss.
Source : Vanguard October 2018
Reproduced with permission of Vanguard Investments Australia Ltd
Vanguard Investments Australia Ltd (ABN 72 072 881 086 / AFS Licence 227263) is the product issuer. We have not taken yours and your clients’ circumstances into account when preparing this material so it may not be applicable to the particular situation you are considering. You should consider your circumstances and our Product Disclosure Statement (PDS) or Prospectus before making any investment decision. You can access our PDS or Prospectus online or by calling us. This material was prepared in good faith and we accept no liability for any errors or omissions. Past performance is not an indication of future performance.
© 2018 Vanguard Investments Australia Ltd. All rights reserved.
Important:
Any information provided by the author detailed above is separate and external to our business and our Licensee. Neither our business, nor our Licensee take any responsibility for any action or any service provided by the author.
Any links have been provided with permission for information purposes only and will take you to external websites, which are not connected to our company in any way. Note: Our company does not endorse and is not responsible for the accuracy of the contents/information contained within the linked site(s) accessible from this page