Optimising cash allocations in retirement portfolios

Stuart Dear


Low cash rates are a global phenomenon and it's likely that they will be at low levels for a considerable period of time. In Australia, the RBA recently cut the cash rate to a new low of 1%. As banks followed suit in lowering their range of deposit rates, many investors are left wondering what can be done to optimise the cash allocation in their portfolios. In this article Stuart Dear outlines how low cash rates may go in Australia, what this means for retirees and also provides a framework for segmenting the ‘cash bucket’ to generate more return.

How much lower can Australian cash rates go?

Common across developed economies in the years following the Global Financial Crisis (GFC) has been an inability of central banks to generate inflation, in spite of falling unemployment rates. Australia avoided the GFC, due to both good luck and good management, but we have not avoided this problem.

Australia’s path to lower cash rates has been elongated compared to the speed with which other major central banks moved to near-zero rates in the wake of the GFC. Chinese demand for our key commodity exports and the effectiveness of lower rates in stimulating house prices and activity, a large part of the Australian economy, have been important. Offsetting this, however, was our poor competitive starting point – an overvalued AUD up above USD1.00 and high relative wage rates – which has meant that for much of the last decade soft wages growth, and lower retail prices in the face of greater offshore competition, have been needed to restore competitiveness. More recently the tighter prudential regulation of banks, and the extra focus of the Banking Royal Commission, has restricted their ability to lend, blunting the effect of low rates. And finally, Australia’s fiscal policy has also been kept deliberately tight, with both sides of politics aiming to restore the federal budget to surplus.

This year global central banks have swung back to easing again, driven by a slower China, the impact of the trade war and the effects of Fed tightening over recent years. With global growth slipping, the local housing market challenged and inflation continuing to print below the RBA’s target, the RBA has cut rates twice in recent months.

While 1% has commonly been seen as an effective floor for the cash rate in Australia, we think rates can go a little lower still - even to 0% given the global experience. This may occur as early as the middle of next year. Further, it's likely that cash rates will be kept at low levels for a considerable period of time; as key structural trends in demographics, globalisation and technology bias growth and inflation rates lower, as debt loads remain high, and as central banks will likely continue to use their limited toolkit to attempt to achieve their narrowly framed (consumer) inflation targets for some time to come.

Figure 1: Australian Cash – headed for zero?

How much should investors hold in cash?

In a low rate environment the group most likely to be impacted by low, and potentially lowering rates, are retirees. Many rely on their allocation to cash to meet their day-to-day expenses and as interest rates have fallen dramatically since the GFC, their ability to generate income without taking excessive amounts of risk has become more difficult. A commonly used investing technique for retirees is the ‘bucket strategy’, which employs three asset buckets: equities, diversified but defensive, and cash (typically holding up to 3 years’ of cash requirements). As depicted in Figure 2, the income and capital from the ‘cash bucket’ is consumed and the income from the riskier buckets flows down to top up the buckets below.

With significantly lower return on cash there clearly is a problem with this model.

Figure 2: A typical retirement portfolio bucketing approach

Optimising cash allocations

In light of the prospect of low cash rates for the foreseeable future, we believe that it makes sense for investors to consider making changes to their ‘cash bucket’ in order to generate more return.

When doing this, investors need to remember the trade-offs involved. By investing in alternative options to cash they are taking on more risk - where in an ideal world of higher cash rates, they wouldn’t need to. As such, investors should choose options that can generate higher returns, while maintaining the level of liquidity they require and relative certainty of return, key features of cash.

Schroders believes a diversified, defensively oriented fixed income strategy that offers periodic income and daily liquidity is best placed to substitute cash for a component of the ‘cash bucket’. Such a strategy should be predominantly comprised of high quality, liquid, publicly traded securities. In addition, it should be a holistic solution that benefits from the diversification of assets, the skill of the manager in selecting individual investments, and from aggregate risk control of the exposures.

Segmenting the cash bucket

Schroders suggests segmenting the cash portion of portfolios into three timeframes which vary according to their requirements for liquidity and certainty.

  • Next 12 months – over this time period investors want the greatest certainty and liquidity. This segment we suggest is maintained in existing cash investments.
  • 1 – 2 years – in this segment investors can take a little more risk to invest for slightly higher returns. However, this allocation away from cash should only be into defensively oriented strategies with high liquidity, and cash should still be a large part of this segment.
  • 2 – 3 years – this segment can take more risk again, and this is where it may make sense to blend some of the higher risk options, alongside cash and more defensive options.

This strategy aims to lift income generation and as depicted in Figure 3, recommends a little less than half the total cash bucket be invested into fixed income, with the aim of lifting income generation, but still largely preserving the certainty of capital and liquidity requirements.

Figure 3: Segmenting the cash bucket


Cash rates are low and likely going lower still. With very little return on cash, it makes sense to consider other alternatives. However, any alternative option must be considered in relation to its ability to provide liquidity and be a source of certainty, in addition to higher prospective returns.

Schroders believe that diversified, defensively-oriented fixed income strategies are the best investments to consider as a substitute for some cash. Our recommendation is to split the ‘cash bucket’ of retirement portfolios into three timeframe segments, and to invest some of segments two and three (those with longer timeframes) into investments which are likely to generate a little more return, without unnecessarily compromising on certainty of outcomes and liquidity.    

Stuart Dear
Deputy Head of Fixed Income

Stuart’s role covers portfolio management responsibility across several of Schroders fixed income strategies, development of fixed income process and strategy, and coordinating the research and implementation functions of the rates sub-team.


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