Commentary on investing generally focuses on the accumulation phase of saving and investing to build up a nest egg of assets and the retirement phase when you use your assets to create an income stream to pay for your life.

But what receives less attention is the phase in-between, when you transition to retirement.

Despite my younger colleague’s insistence that I am ancient and must be days away from retirement I have not experienced this period myself. However, I have managed my mother’s finances for the last 15 years which included her transition to retirement.

Before getting into the lessons learned from my own experience with my mother, it is worth noting that few people go through this process cleanly.

We may envision walking into work on our 67th birthday for a farewell party and a gold watch but that is rare. For many people the transition to retirement may not go as planned as health issues, corporate downsizing or burnout throw a wrench in plans. For people with adequate savings retirement may come early.

The challenges of retirement planning


Investing theory tells us that as we approach a goal like retirement it is important shift our portfolio into more defensive assets to limit volatility.

This is to combat sequencing risk, which is a fancy way of saying that if the market drops significantly as you start drawing down your portfolio it may not last long enough to cover your retirement.

Sequencing risk is a legitimate concern. But longevity risk is a concern as well which is the potential for outliving your money.

To address longevity risk the best approach is to keep growth assets in your portfolio. If the ways to address those twin risks seem conflicting it is because they are. The heart of this conflict is that none of us know how long we will live which makes it very difficult to plan retirement.

Aggressively de-risking your portfolio by shifting to defensive assets increases the chance you will outlive your retirement savings. Not being aggressive enough means that if the market drops significantly early in retirement you may never recover.

The bucket approach to portfolio construction


I took over my mother’s portfolio after my parent’s divorce with around 5 years to go until her retirement. The markets were in the midst of bottoming out during the GFC. Her portfolio was supplemented by an infusion of cash after the sale of a house.

The values presented by the market downturn and the cash provided the perfect opportunity to get her portfolio positioned for her transition to retirement. The approach I took was a variation of the bucket approach to portfolio construction.

The bucket approach to portfolio construction is designed to mitigate the twin risks retirees face.

Sequencing risk exists because the spending needs during retirement necessitates the selling of assets in down markets. Forced to sell low there is less of an opportunity to take advantage of market recoveries. This means that a retiree could run out of money prior to death.

The central issue is not the market drop. That periodically happens in markets. The real issue is the need to sell during these downturns. The bucket approach addresses this issue by creating short, medium and long-term grouping of assets.

The short-term bucket is invested in cash and is designed to meet near term spending needs. If the market drops significantly retirees can draw on this cash instead of selling depressed assets.

The longer-term buckets can be used to support spending needs and replenish the cash bucket through asset sales and dividend and interest income.

For my mother I set-up a two-bucket system. The short-term bucket consisted of cash that equalled approximately 5 years of estimated spending in retirement. The longer-term bucket consisted of shares.

The cash bucket


Defensive assets are utilised to lower the volatility of a portfolio. Bonds bounce around in price less than shares so any allocation to bonds will lower the amount an overall portfolio changes in value. Cash has no volatility. A dollar is a dollar and will not change in value at all in nominal terms.

There are several factors at play when making a decision about the size of the cash bucket.

Since the purpose of the cash bucket is to ride out market volatility the question is how long of a time period is sufficient. The average bear market takes 27 months to recover and reach the value before the fall. But in some cases, the period has extended for 5 years in particularly harsh bear markets.

Some retirees will decide that a one-year cash supply is enough. I opted for 5 years for my mother in a nod to conservatism but also because I choose two buckets instead of the standard three.

The second bucket is generally used for medium-term assets, and primarily made up of bonds. I choose to forgo this bucket since I didn’t consider bonds an attractive investment given the low interest rate environment.

It is also important to remember that if you choose to invest in bonds through an ETF or Fund their value can continue to decline in a rising interest rate environment. Something we’ve experienced in the last 15 months.

Given the reduction in interest rates during the GFC I feared this very scenario. I turned out to be very wrong as rates stayed low and then dropped even further 12 years later during COVID.

The share bucket


The lack of a second bucket also influenced the approach I took with the share bucket. In my own portfolio I tend to gravitate towards companies with lower business risk by focusing on larger companies, companies that are non-cyclical and those with strong finances that pay above average dividends.

While not a hard and fast rule, these companies tend to be less volatile and generate cash flows that can be used to replenish the cash bucket as it is depleted by paying for mother’s living expenses. My mother did not have a large enough portfolio to support her life just through dividends, but they could support about a third of her spending needs.

This meant that during the 5 years it would take to deplete the first bucket another 1.67 years of cash could be built up without having to resort to selling off her assets. While I fully intended to start selling down assets during her retirement this provided extra protection and allowed me to do that opportunistically.

Part 2: The best laid plans


I felt comfortable with the plan for my mother’s finances, but I knew that the unpredictability of life would require course corrections along the way.

You can read part two of this article here which explores the lessons learned as she transitioned into retirement.

If you have successfully transitioned to retirement I would love to hear any lessons you’ve learned along the way so I can share them with our readers. Please email me at [email protected].