A lot has been said and discussed about asset allocation. But asset allocation remains beyond reach of common investors. Mostly you need an advisor to design asset allocation with precision. In this article we shall discuss a simpler strategy which can replace the asset allcoation. This strategy is known as Bucket Strategy. It is seen that many investors do not have sufficient liquidity during this period of lockdown. As the markets have fallen down the value of investment has gone down and hence investors are not able to take out the money when they need it the most.
Why do I write more on strategies and investment basics than I write on scheme performance?
I believe that investing is more successful by following the basic principles than by running behind the scheme’s performance. Scheme performance and top schemes keep on changing. However the basics remain the same. Today’s top performing scheme may not be the same tomorrow. You can have very successful investing stint even if you invest in mediocre scheme but if you strictly follow the basics of investing
Why Bucket Strategy?
Objective of any investment portfolio is to ensure availability of money (liquidity) at the time of your requirement. This liquidity must come with anticipated returns. If you don’t get required money at the time when it is required, the objective of the investment is not fulfilling.
For you to get the anticipated returns and required liquidity, you must invest in low risk assets / schemes.
But the problem is that if you invest in low risk assets / schemes you may end up getting meagre returns.
The alternative is to invest money in aggressive assets / schemes which are expected to yield higher returns. However, aggressive assets / schemes are volatile. It might so happen that these assets / schemes may be showing negative returns at the time when you actually need money. So if you wish to have money (liquidity) to be made available you can’t invest in aggressive schemes.
The problem is, if you invest in aggressive schemes you may end up getting negative returns at the time when you need them.
Two most important objectives of any investment is to reduce the risk and optimize the returns. Bucket strategy tries to balance between the liquidity and returns, Bucket strategy balances between safety and aggression. Bucket strategy is simple and effective.
What is Bucket Strategy?
Let’s take an example. Mangoes can be separated in 3 buckets. In Bucket 1, we can put completely ripe mangoes which are supposed to be consumed in the next couple of days. In Bucket 2, we separate half ripe mangoes which are meant to be used in a week’s time. And in Bucket 3, we shall keep completely raw mangoes which will become eatable in, say, 15 days of time. This way we are able to separate the three types of mangoes based on how much they are ripped. This will facilitate us to use the right mango at the right time.
Bucket strategy for investing works similarly. This strategy is useful for lumpsum investments more accurately than the SIP investments. Hence, this strategy can be more profoundly used while retirement planning.
In Bucket Strategy investments are divided in 3 buckets. Investment in each bucket is meant for a different tenure.
The investment period for each bucket can be chosen as,
Investment, maturity of which is required within 3 years
Investment, maturity of which is required after 3 years but before 6 years
Investment, maturity of which is required after 6 years
One can also have a 4th Bucket as well, if you wish to fine tune the investment over a longer period.
In case you wish to have 4th bucket, your investment in 3rd bucket may be held between 6 to 10 years
Investment, maturity of which is required after 10 years
Here is how you can distribute the investment amount in these 3 buckets. The kind of assets / schemes that can be used to invest in each bucket are also mentioned in the table.
|Bucket||Investment Period||% of Investment||Asset Type||Scheme Type|
|Bucket 1||0 to 3 years||30%||Cash and Debt||FD, Ultra Short Term Funds, Short Term Funds|
|Bucket 2||3 to 6 years||30%||Debt & Equity||NCD, Conservative Hybrid, Balanced Hybrid & Aggressive Hybrid Funds|
|Bucket 3||6 years & above||40%||Equity||Large Cap, Multi Cap & Mid Cap Funds. Direct Equities in some cases|
In the above example the period of each bucket, % of allocation in each bucket and schemes can change depending upon the age and other priorities of the person investor.
Advantages of Bucket Strategy
As seen in the above table, the first advantage is that the strategy is pretty simple to use. There is no need to get into detailed asset allocation.
This strategy solves both the problems. The problem of liquidity and the problem of risk.
You can see in the table above the schemes considered in the Bucket 1 are low risk schemes with almost no volatility. Low or no volatility will ensure that the amount does not fall in value and rise in value steadily. This means Bucket 1 will ensure availability of the money during the first 3 years by compromising on the returns.
The assets and schemes considered in Bucket 2 are medium risk schemes. The returns of these schemes are expected to stabilize over a period of 3 to 6 years. However, these will reap better returns than the schemes in Bucket 1. So, we are ensuring improved returns by taking a little higher risk over a little longer period.
Similarly, the assets and schemes considered in Bucket 3 can be high risk schemes among all schemes considered in Bucket 1 and Bucket 2. At the same time since these are high risk schemes, they are expected to yield highest returns among schemes considered earlier. But since the schemes are held for a longer period ( in this case 6 years and above) the returns are expected to stabilize over these years. Here we are ensuring highest returns by compensating on the time period of investment.
This way, the average of returns of the 3 buckets can be close to the expected returns. And we can meet the objective of the investment.
|Note: Equity oriented investments held for longer periods are more stable. The returns are more predictable over a larger period. The higher the time frame better the returns and lower the risk.
Read:7 Things Existing Investors Should Do During Market Volatility Due To Elections
Drawbacks of Bucket Strategy
Bucket strategy may be considered as a somewhat superficial strategy as compared to asset allocation and goal planning. In case of proper Investment Planning we get through the process of Risk Profiling, Asset Allocation and then map each asset to the goals as per their maturity. So, when we map assets to each goal the amount is expected to be available exactly during that goal. But Bucket Strategy is a more broad strategy and is not fine tuned to your financial goals.
We at Bonvista, thoroughly discuss with our investors the probable investing strategy that we adopt for them. Once a strategy is decided, the model portfolio is prepared and implemented accordingly. The model portfolio is available throughout the investment period which helps us track their investment against the benchmark of the Model portfolio.
Let me know how you plan your investment portfolio. Have you differentiated your investments in different buckets based on your priorities? You can ask your questions in the comment box below.