Why the four-bucket method could be the holy grail

Caitriona Wortley, Head of Distribution Allianz Retire+, explains why Australians need to refocus on the end goal in the search for secure retirement income.

According to legend, the Holy Grail was a magical cup imbued with “miraculous powers that provide happiness, eternal youth or sustenance in infinite abundance”.

That perfect product pitch sent an awful lot of fictional knights on misguided adventures with unfortunate conclusions. In hindsight, the Holy Grail marketing department probably over-sold the concept – at the very least there was poor risk disclosure.

Some source materials credit three knights as finding the magical cup but most seekers, side-tracked by events, ultimately lost sight of the main goal.

Similarly, the long-held promise of the Australian superannuation system as the deliverer of sustainable retirement income is fading from view for a large cohort of members in an era of low-interest rates and rising risks.

But the problem could be that many investors are looking in the wrong places.

Beyond the end of the road

Without a doubt, superannuation has taken more Australians further down the road to a comfortable retirement than most would have achieved alone.

However, the contribution-and-investment mindset that has been so successful in accumulating super assets – now about $3 trillion – could prove counterproductive as retiring members look to transform those savings into income for life.

Faced with a finite pool of assets, uncertain investment returns and an unknown number of years to fund, retirees often take a far too conservative approach in a bid to ward off their greatest worry: running out of money.

“In fact, our research has shown that 61 per cent of retirees fear running out of money more than death itself1.”

The well known ‘bucket strategy’ has been a common way to help manage the drawdown of assets at retirement, focused on balancing the need for steady income and capital growth.

A typical ‘bucket strategy’, will allocate a certain proportion of savings to cover short, medium and long term needs. Investments will be apportioned to cash, fixed income and equities according to risk tolerance and time horizon.

This strategy is often used as an effective way to mitigate behavioural tendencies in retiree investors by shifting the focus away from the volatility of markets.  It’s popular with advisers, with recent research from Investment Trends indicating that 55% of advisers2 use this approach with clients as their retirement strategy and commenting it has been effective in the past.

Yet in what has become a persistent, low yield environment, the three-bucket approach (with its 60/40 tilt) may benefit from far greater exposure to growth. Particularly as we look to sustain ever-increasing retiree lifespans.

Enhancing the ‘bucket strategy’

In the context of delivering sound retirement outcomes moving forward, the current low-interest rate environment, (now compounded by the COVID-19 crisis) raises difficulty with the bucket strategy. Effectively the short term bucket may struggle to deliver the returns needed to fund short term cash flow requirements.

We believe the holy grail of retirement income, or at least an enhanced outcome in the current environment, is likely to be found in a fourth bucket that allows investors to increase their growth allocation.  It will also serve to mitigate the unique retirement risks – namely: longevity; sequencing; and, increasingly, behavioural – by incorporating a protected equity strategy.

How to find enough

As an example, a protected equity strategy may fulfil the role of providing retirees with exposure to growth via market-linked returns with the comfort of knowing they are protected from downside risk by a ‘Floor’.  An investment will never go lower than the chosen protection ‘Floor’3 and will participate in market-linked growth up to a corresponding ‘Cap’.

Furthermore, adding a fourth bucket (a retirement specific solution) to the total portfolio mix allows retirees to take on more exposure to risk through their asset allocation without the downside trade-off.

Let’s walk through an example; a standard three-bucket approach might apportion:

  • 15 % in bucket 1 (cash);
  • 25 % in bucket 2 (fixed income); and
  • 60 % in bucket 3 (equities.)

An enhanced outcome using a four-bucket approach might be:

  • 5 %  in bucket 1 (cash);
  • 10 % in bucket 2 (fixed income);
  • 20 % in bucket 3 (retirement specific protected equity solution ; and
  • 65% in bucket 4 (equities)

This equates to 85% in equities, 10 % in fixed income and 5 % in cash.

This method will increase the potential for high returns due to the higher growth allocation while providing lesser reliance on lower-yielding assets such as cash and fixed income. Also, due to the protective ‘Floor’, the potential for downside in ‘bucket 3’ is limited.

In today’s environment, financial advisers have an incredible task on their hands in meeting the post retirement income challenge. But the broader financial services industry also has a role in helping them ensure their clients have confidence and certainty in meeting their objectives. To enable that we need to deliver creative solutions that enhance advisers’ existing strategies and approaches.

Along with the use of powerful new scenario-modelling tools – such as the ‘Allianz Retire+ Retirement Portfolio Illustration Tool’  technology by Invesfit- advisers can lead retirees on the quest of a lifetime. With the right products, tools and advice, retirees should have more than enough.

Allianz Retire+ offers Future Safe, an innovative retirement investment product that seeks to adequately protect the equities component of a portfolio, utilising a Cap and Floor protection strategy.

1Allianz Life, Reclaiming The Future Study,” 2010.
2Investment Trends, Retirement Planner Report, ‘Planners familiarity and usage of retirement income strategies’, 2020
3Before fees and taxes