Continuing recent posts updating my past descriptions of retirement strategies, let’s look again at time-segmentation (TS) or “bucket” strategies.
The basic implementation of time segmentation strategies sets aside enough cash and short-term bonds to cover the next few years of retirement expenses, let’s say five, then covers the following few (let’s say years six through ten) years’ expenses with intermediate bonds, and finally allocates any remaining assets to stocks.
Note that this is a markedly different way of allocating assets than is typically used by other strategies that base equity allocation on the largest loss a retiree can stomach in a market downturn and the optimal asset allocation to avoid prematurely depleting a savings portfolio.
Many retirees will find that setting aside five or six years of expenses in a cash fund will be a significant portion of their investable assets so this might be a dramatically different allocation.
Here’s an example. A retiree wants to spend $40,000 annually from a $1M portfolio. She invests a little less than $200,000 in cash and short-term bonds (the discount rate is low, especially in today’s capital markets, so we can roughly just multiply annual spending by 5) to cover expenses for the next five years. She invests a little less than $200,000 (less because they yield a little more) in intermediate bonds and roughly $600,000 in stocks. It is her estimated future spending that determines her asset allocation of 20% cash, 20% bonds and 60% stocks.
TS strategies don’t typically recommend an annual safe spending amount like the $4K in this example but this can be estimated by any of the (preferably variable) spending strategies.
This part of the TS strategy is based on matching asset duration to the duration of expenses and is financially sound.
Asset duration, in simplest terms, refers to the recovery period typically needed after a market downturn or interest rate increase. The duration of an expense is essentially the number of years until it is due but expected inflation must be considered, too.