Some financial advisers recommend that retirees set aside one to two years of living expenses if possible in a cash fund. This is to act as buffer to avoid having to sell growth assets to pay retirement income during a market downturn.
Critically, a volatility buffer may also give investors greater peace of mind during times of higher market volatility, enabling them to concentrate on their long-term goals without being distracted by market "noise".
The level of volatility following the United Kingdom’s Brexit vote to leave the European Union may prompt more investors to consider consulting a financial adviser about whether a cash volatility buffer is appropriate for their circumstances.
Often investors begin to build up their volatility buffer in last few years before their intended retirement. One approach is to direct a proportion of super contributions into cash to establish the buffer.
The size of the buffer and how it is built-up will depend on such circumstances as the size of an individual’s retirement savings and professional advice received.
There is obviously a price to be paid in potentially forfeited returns by having a low-earning cash buffer – particularly given that interest rates are extremely low.
A key question is how to top-up the cash bucket or buffer if necessary during retirement. Some advisers may suggest using a proportion of income from an investor’s main diversified portfolio to replenish the cash buffer from time to time. Proceeds from regular rebalancing of an investor’s main diversified portfolio can provide another source of top-up money.
A recent article on the US website of investment researcher Morningstar -Retirement bucket basics – emphasises the "psychological support" that a volatility buffer can give investors during difficult market conditions. That support comes from knowing they have one or two years’ living expenses set aside.
Morningstar adds: "One of the insights we gain from looking at managed fund inflows and outflows is that investors levy big costs on themselves from year to year by buying [managed] funds high and selling them low. Employing a bucket approach is designed to help retirees avoid those bad timing decisions that can erode long-term returns."
Having an appropriately-diversified long-term portfolio is obviously a core buffer against higher volatility. And having a cash buffer may provide an additional layer insulation.
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Robin Bowerman is Head of Market Strategy and Communication, Vanguard Australia. As a renowned market commentator and editor Robin has spent more than two decades writing about all things investment. |
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