Buffer Assets – What are they and why do you need them?

My week usually involves reading articles written by US academics who specialise in retirement planning. This week I’ve summarised an article about retirement written by Retirement God, Wade Pfau. It’s pertinent in the current volatile period for investing, and it explains a particular concept better than I can. I’ve summarised the article and translated some of the American English to make it a bit easier to read.

Investing involves risk. When you put your money to work in the financial markets there’s always a chance that you could lose money, over any time. Most of the time, especially over longer time frames, asset prices go up. But they don’t have to. That risk is always there.

But there are things that you can do to control the risk that you face. And one of the simpler things you can do when you are making withdrawals from your investments and pensions, is to make use of buffer assets.

What are Buffer Assets?

Buffer assets serve as a buffer between the vicissitudes of the market and your withdrawals. Essentially, buffer assets allow you to control when you need to sell volatile (and higher returning) assets from your portfolio to fund your spending. They are there to help manage your sequence of returns risk (to avoid Pound:Cost Ravaging).

Buffer Assets are very low risk assets whose values don’t change in value in the same way as the assets in your investment portfolio. Cash Deposits and Premium Bonds are the most common examples of Buffer Assets.

How Buffer Assets Can Help Manage Sequence of Returns Risk

Ideally, we would avoid selling assets in our portfolio when prices are down, to minimize our sequence of returns risk. This is where buffer assets can help.

Buffer assets can help mitigate sequence of returns risk by separating the timing of your spending from the timing of the sale of assets in your investment portfolio – at least to a point. There are two main approaches for how to do this.

  • The first approach is to treat your buffer assets as essentially reserves. With this approach, you keep a big pool of money off to the side that you can spend from in the years when your portfolio is down.
  • The second approach is to use your buffer assets more as working capital. You have a pool of money that funds your spending – whether assets are up or down – and you refill that pool whenever it is advantageous. So, for instance, say that I am using this approach and I have enough buffer assets to cover three years of spending. During the first year, I’ll take my distributions from my buffer assets, and then at the end of the year I’ll look to see how my portfolio performed. If the markets cooperated, I’ll sell enough risky assets to bring my buffer assets back up to 3 years of spending. But if the markets had a bad year, I wouldn’t do anything. Next year I’ll continue to eat into my buffer. Then at the end of the year, I’ll look at my returns again and see if the market has recovered. If it has, I can start building back up my buffer.

The Trade Off

While buffer assets are a great tool for managing your sequence risk, there’s always a tradeoff. Holding buffer assets means that you are holding money back from your investment portfolio. You need to decide on the balance between your investment portfolio and your buffer assets.

How Big a Buffer Do You Want?

Like most financial planning questions, there is no right answer. It comes down to what you feel comfortable with – balancing the benefit of reducing your sequence of returns risk against the cost of reducing the potential upside of your investment portfolio’s growth.

The answer, as is so often the case, is to stress test your retirement plan. A good stress test can show whether you would have exhausted your proposed buffer assets in the past, and what the circumstances were that led you to run out of buffer assets. You could take the view that, if there was a big shock in financial markets, you might be happy to reduce your discretionary spending, to preserve your buffer assets. Or you may take the view that you would want to continue with your planned spending (you only live once!); in which case, you might need a larger buffer. Once you have completed the stress test, you can set the level of your buffer assets rationally.

Buffer assets can be a great tool, and there is evidence that they can improve overall outcomes in the right situations. It always comes down to what makes sense to you – and the tradeoffs that you are prepared to make in your retirement income plan.

Philip Wise | philip@sussexretirement.co.uk

Managing Director and Chartered Financial Planner


This guide is for information purposes and does not constitute financial advice, which should be based on your individual circumstances.
The value of investments may go down as well as up and you may get back less than you invest.
Investing in shares should be regarded as a long-term investment and should fit in with your overall attitude to risk and financial circumstances.
A pension is a long-term investment, the value of your investment and the the income from it may go down as well as up. Your eventual income may depend upon the size of the fund at retirement, future interest rates and tax legislation. 

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