The Problem With Balanced Funds In Retirement

Retirement planning is a multifaceted endeavour with numerous financial instruments available to secure your financial future. Balanced funds and exchange-traded funds (ETFs) are popular choices due to their diversified nature, but they may not always be the ideal solution when it comes to retirement withdrawals. In this article, we'll explore the disadvantages of relying solely on balanced funds or ETFs for your retirement income and discuss an alternative approach that could better serve your financial needs.

The Balanced Fund and ETF Appeal

Balanced funds and ETFs are designed to provide investors with a diversified portfolio that typically includes both equities (stocks) and fixed-income securities (bonds). This diversification aims to strike a balance between growth potential and stability, making these options attractive for retirement planning.

The Pitfall: Forced Equal Withdrawals

One of the drawbacks of using balanced funds or ETFs for retirement income is the way withdrawals are structured. In these investment vehicles, you typically withdraw a fixed percentage of your portfolio value regularly. While this might seem straightforward, it can lead to significant disadvantages:

1. Market Timing Risk: By withdrawing a fixed percentage from your balanced fund or ETF, you are essentially forced to sell assets in both the equity and fixed-income portions of your portfolio. This can be problematic when equities are performing poorly, as you might end up selling stocks at a low point.

2. Missed Growth Opportunities: Equity investments tend to offer higher growth potential over the long term compared to fixed-income securities. When you withdraw equally from both, you miss out on the potential gains that could be achieved by leaving your equities untouched during market downturns.

3. Reduced Long-Term Returns: Over time, withdrawing from the equity portion of your portfolio, especially during market downturns, can erode your potential for long-term returns. In contrast, fixed-income investments may provide more stability but generally offer lower returns.

An Alternative Approach: The Cash or Fixed Income Bucket

To address these disadvantages, many retirees adopt an alternative approach known as the "cash or fixed income bucket" strategy. Here's how it works:

1. Segment Your Portfolio: Divide your retirement portfolio into distinct segments, each with a specific purpose. For example, create a "cash" or "fixed income" bucket and a "growth" bucket.

2. Monthly Income Needs: Cover your monthly income needs primarily from the cash or fixed income bucket. This allows you to avoid selling equities during market downturns.

3. Periodic Re-balancing: Periodically re-balance your portfolio by selling assets from the growth bucket to replenish the cash or fixed income bucket. This re-balancing helps maintain your desired asset allocation.

Benefits of the Cash or Fixed Income Bucket Strategy

- Reduced Market Risk: By focusing on cash or fixed income for immediate income needs, you reduce the impact of market volatility on your withdrawals.

- Long-Term Growth Potential: The growth bucket, primarily consisting of equities, can continue to grow over time without constant withdrawals, potentially increasing your overall returns.

- Peace of Mind: Knowing that you have a stable source of income from the cash or fixed income bucket can provide peace of mind during market fluctuations.

In Conclusion

Balanced funds and ETFs can be valuable components of a retirement portfolio, but relying solely on them for withdrawals may come with drawbacks. The cash or fixed income bucket strategy offers a practical alternative that provides stability, reduces market risk, and allows you to capitalize on long-term growth potential. Consider consulting with a financial advisor to tailor this approach to your specific retirement goals and needs.