Social Security as part of your portfolio
BY ANDREA COOMBES,
MARKETWATCH
COPYRIGHT © 2013 DOW JONES & COMPANY, INC. ALL RIGHTS RESERVED.
MARKETWATCH — 08/19/13
Counting benefits as fixed income: opportunities and risk.
You may be counting on Social Security but if you’re not counting Social Security as a part of your overall asset allocation, you may be missing out on bigger gains in your retirement-savings portfolio.
Some financial advisers say retirement investors should consider the value of their Social Security benefits as a piece of their fixed-income investments.
Generally, adopting that strategy would mean shifting a big portion of your investible assets out of bonds and into stocks.
For example, if you’ve got $300,000 worth of Social Security benefits and a $700,000 investment portfolio, then your total portfolio is worth $1 million. If you wanted 50% of that portfolio, or $500,000, allocated to fixed-income investments, then just $200,000 of your investment portfolio would be in bonds, while $500,000 would be in equities.
There are different ways to gauge the present value of future benefits; one simple tactic is to add up your monthly benefit (you’ll have to guess how long you’ll be alive to collect benefits).
“We go through a process where we value someone’s Social Security like a TIP,” or Treasury Inflation Protected security, said Bill Meyer, chief executive of Social Security Solutions, which offers fee-based claiming tools and services. “Then we add it into the household’s allocation.”
In one scenario involving a hypothetical single person who claimed benefits at age 70, owned an investment portfolio worth $500,000, and employed a tax-efficient withdrawal strategy, Meyer said he found that this strategy led to 8 extra years of retirement income, compared with not counting Social Security in the person’s investment allocation.
Famed investor Jack Bogle, founder of the Vanguard Group, seems to agree. In an interview in June with investment researcher Morningstar, Bogle suggested retirement savers should consider the value of their Social Security benefits in their asset allocation.
First Bogle cited his penchant for basing one’s asset allocation on one’s age. (If you’re 40 years old, you have 40% of your investments in fixed income and 60% in equities. By the time you’re 60, you’ve got 60% in fixed income, 40% in equities).
Then he talked about Social Security, citing a saver who has $300,000 saved in an investment portfolio.
“If you capitalize that stream of future payments, most people’s Social Security is going to be…let’s say $300,000 for an average investor,” Bogle said. “If you have $300,000 all in equity funds, even equity-index funds, and $300,000 in Social Security, you are already at 50/50” fixed income versus equities, he said.
Meyer, of Social Security Solutions, acknowledged that many people “will be uncomfortable with taking on a larger stock position,” he said.
In his practice, after coming up with a value for a client’s Social Security benefits, the next step is a conversation with the client.
“That’s where Social Security meets risk management,” he said. “What does this really mean to have more stocks? How are you going to feel when the market goes up and down? A lot of people will say, ‘I understand this concept but I really don’t feel good when my 401(k) goes down $50,000,’” Meyer said.
People need to understand that “with the additional stock exposure there will be more volatility,” Meyer said. “With our clients, we’ll give them a target asset allocation and then we’ll give them a range.”
He tells clients: “Given your amount of Social Security, you could tilt your equity exposure as much as X.”
Then, Meyer said, “We show them the additional money they can get by having more stock. But then we run a Monte Carlo simulation to show them the volatility. What’s the most you could win, but what’s the most you could lose.”
Also, he warned, married couples—who can employ a variety of Social Security claiming strategies—might have a harder time estimating the value of their future benefits.
Income, not assets
Some disagree with this approach. “I advocate including [the value of Social Security benefits] in a net-worth statement, but I don’t necessarily go so far as to include it in a traditional investment allocation,” said Bob Klein, a certified financial planner and president of Retirement Income Center in Newport Beach, Calif. who also is a MarketWatch RetireMentor contributor.
“It’s a psychological issue, more than anything,” Klein said. “Say we’re in a real down market—they’re not going to be comforted necessarily by the fact that they have Social Security. They’re focusing on the fact that their portfolio is going down.”
Klein said he prefers to calculate the present value of projected retirement income from a client’s various retirement-income sources, such as an investment portfolio, Social Security and annuities.
“You’re not looking at assets per se. You’re looking at income and how the income is allocated,” he said.
One reason he likes that approach: It forces a focus on generating retirement income.
“The reality is you need income to live on and, furthermore, with life expectancies increasing, you’re going to be retired, chances are, for a lot longer than your parents were,” Klein said. “Income is the name of the game at that point.”
He added: “It’s important to recognize that Social Security does have value to it and include that present value, whatever it is, in a financial statement, but don’t include it in a traditional investment allocation format.”
How do you go about figuring the present value of your benefits? Looking at your statement on SSA.gov can help, but you will have to make a guess as to how long you will live. And if you’re many years away from retirement, you’ll have to make some guesses as to how much you’re likely to earn later in your career.
“You have to use a lot of assumptions,” Klein said. “The closer you are to full retirement age, the easier it is to do the calculation. However, you still have to make assumptions about longevity, which is tricky.”
Others agreed with Klein’s approach.
Counting Social Security as part of your investment allocation, and thus tilting your investments more heavily toward equities, puts your portfolio at too much risk, according to an article written in 2009 by Paul Merriman, president of the Merriman Financial Education Foundation, a longtime financial adviser and a MarketWatch RetireMentor.
Merriman said he still agrees now with what he wrote then.
“In a serious bear market, that heavy equity allocation could wipe out your portfolio’s ability to keep generating the income you need for retirement,” he wrote in the article.
“You’d still have your Social Security, but you might not have much else. You could be forced to drastically cut back your lifestyle—an unfortunate result that started when you didn’t think clearly about this,” he said.
Comments
(The copyright gods would prefer they be attached. Simple copy & paste works.)
Good article. Gives both sides of this issue. Yes - that's Bogle's view. And, would suppose if you have a DB pension, rental income, annuity payments. etc., he'd throw that all in too. Suspect most professional advisors would approach it in a similar fashion. So, I have no quarrel with viewing it that way - if it works for you. ... Some also recommend counting anticipated inheritances as bond holdings. (In this case, better hope great uncle Ben doesn't develop a proclivity for junkets to Vegas or beautiful younger women during his final years:-)
On the other hand, Bogle's emphasis on bonds in your portfolio is somewhat higher than what I and many others would recommend. Even he has been a bit "confounded" by the historically low returns on bonds in recent years. By including the other areas mentioned in your income stream or bond position you effectively reduce the amount of "real" or actual bonds you need to hold - likely a benefit in this environment. Also, as the article mentions, a lot of this is psychological - having to do with your own mind-set.
I've always liked Bogle. A lot less BS with him than with many of the "charlatans" out there - as Louis Rukeyser used to call some of these fellas. But, even Bogle'd be the first to say his approach is right for him - and not necessarily right for everyone else. My take? I think it all points to the importance of being as widely informed as you can (including thru forums like this) and then charting your own course. Don't overlook some type of modified version of Bogle's approach. FWIW
No....what I mean is, count on SS like you count on a bonus. Sure you rely on getting it while you are dreaming of buying a new car. When it always does not come through, you rant a little, and then get over it. You live.
If a standard, generally accepted definition says yes or no, then the question answers itself. If there is no standard definition, then anybody can include whatever they darned well want to, and the term "portfolio" means whatever you want it to, so essentially becomes meaningless.
FWIW, Investopedia gives the following definition:
"A grouping of financial assets such as stocks, bonds and cash equivalents, as well as their mutual, exchange-traded and closed-fund counterparts. Portfolios are held directly by investors and/or managed by financial professionals. "
If the question, as I suspect, is really "should SS be considered an asset for retirement planning purposes", I did, and believe that that is a valid approach. If you were to take a sum of cash and convert that to an annuity (which I certainly DO NOT recommend for the average investor), then that also should be included as a retirement asset for planning purposes. Likewise, a defined benefit retirement pension, if anyone still has one of those, and has confidence in the plan. Likewise income property, etc. Why would you not include any potential retirement income in your overall planning?
Guess I should have been more explicit in my reply. As far as the poster goes, I offered some general observations based on having followed John Bogle a good many years. His writings were among the first I read and enjoyed on the topic of investing. Frankly, am loath to advise anyone on anything financial, believing - as I'm sure you do - the best long-range investment plans derive from within and are tailored specifically to address the circumstances and needs of the individual. Thanks for your thoughts as always
I've found it easier here in Wacousta to think in terms of investment portfolio(s) vs. wealth portfolio. What really matters folks? For me it's overall wealth and where it lies.
And that of course leads us to the Elder Baron R. suggestion to have 1/3 of your wealth in securities, 1/3 in real estate and 1/3 in rare art. [note that I define rare art in other ways but it's not Beanie Babies AND as a matter of course, I'd include my social security in the my securities].
and so it goes,
peace,
rono
I'm as guilty as anyone, and Investor and I have sorta agreed that in my particular case it should be regarded as an "investment portfolio" rather than a "retirement portfolio", because our actual retirement income seems to be doing fine without touching the investment side of things. I would guess that "investment portfolio" and "wealth portfolio" are synonymous, but because we don't have a standard usage here on MFO I'm not even sure of that.
How Bogle transmogrifies SS into a bond-like instrument I'm not sure, unless he is strictly looking only at hopefully dependable scheduled income, and substituting SS for equivalent bond income without regard to the actual bond value. In that case, the same rational would seem to apply to an annuity also.
The whole thing seems a bit shaky to me, since bond income may or may not keep pace with inflation, and then are we talking about holding bonds directly or through a fund, where anything can affect the intrinsic value of the holding. Pretty messy, I think, and too much room for slop to be very helpful.
Keep it simple:
1) calculate needed retirement income, adjusted for inflation
2) calculate all anticipated income, from all sources other than investments
3) subtract anticipated income (2) from needed income (1)
4) if the income meets the needed level, you can contemplate an "investment" or "wealth" portfolio.
5) if there's a shortfall, then you need to seriously work on your "retirement" portfolio. You now know the income needed from that portfolio, and can determine your equity/bond/fund distribution in an intelligent way to try and meet (and hopefully surpass) that need.
I'd close with "peace" also, per rono, but it seems to be hard to come by these days.
Regards, as always- OJ
I am, however, sometimes frustrated by the term "cash" which gets thrown around quite a bit. Most of us, I suspect, have "enhanced" our definition quite a bit by dipping into riskier assets with cash-like characteristics. So one guy's reported "40% cash" position may look quite a bit different from someone else's 40% cash stake. "Bond" too is a term open to different interpretations. Some think only in terms of AA or higher quality. Others include junk and EM as part of their bond position. That's one hell of a difference in risk-reward characteristics and also how they'll behave under different conditions.
I've spent an hour trying to uncover a M* interview Bogle did recently. All leads failed - perhaps because I'm not a registered M* user. But, apparently, he left the impression Social Security should suffice as most people's "bond" holdings - so we should now plow most everything we hold that's liquid into the stock market. I do fear the ol boy's beginning to lose it! Those 1% bond yields may have driven him over the edge. The Boggleheads are going nuts on their board over his comments.
Here's the best short snippit I could dig up on his recent remark. Not the transcript (which I'd really like to read) http://www.wcvarones.com/2013/06/john-bogle-social-security-is-new-fixed.html
In discussing that however, I pointed out that as things look now we do not anticipate needing to draw down that portfolio for living expenses. Investor responded that in that case it really shouldn't be considered as a "retirement" portfolio, but rather as an "investment" portfolio (held while we are retired, it's true), and that indeed a different calculus might apply: If there is no strong need to bolster return for living expense, perhaps a lower risk/return is OK.
Over the years I've become aware that seemingly no two people on Fund Alarm or MFO seem to calculate their "portfolio" in exactly the same manner. And that's quite understandable, as probably no two of us are looking at exactly identical situations, and after all this is an informal forum- not held to commonly accepted accounting standards, thank goodness.
And you're quite right re the cash or cash equivalent allocations causing a great deal of head scratching. If you keep a bundle aside for living expenses in case of disaster or extraordinary expense, is that part of your portfolio or not? Is RPHYX a cash or bond allocation?
This is why comparisons of "portfolios" in this informal MFO environment really isn't possible. And that's not really a big deal either. My original growl re the word "portfolio" as used in this thread was simply because it was being used as if it were a commonly accepted definition here, and I just don't see that it is.
From your link above: "Bogle has a great point: use your Social Security income for the fixed-income portion of your portfolio, and allocate the rest to stocks (and precious metals, obviously)." What total bunk! A pension isn't "fixed income"? Nor rental property? Nor annuity income? Nor trust income? And do any of those deserve to be considered a part of a "portfolio"? I don't think so, and neither does the Investopedia definition.
All of these conveniently unmentioned factors are exactly why I prefer to look at the whole thing as in "keep it simple", above.
Take care- OJ
Agree with you - to advise mom & pop investors currently in retirement to throw all their cash into risky assets and count SS as their "bond" or "fixed income" portion is bunk. It's also not characteristic Bogle. As someone else infers, first time the markets experience a sharp drop they'll dump & run ... and at the worst possible time.
Bogle's fine - but not a Saint. Not sure what his "gig" is nowadays. ... Google him and he's everywhere. Is he garnering income from his appearances? Book sales? Who knows? If Ted or anyone else comes across that M* Interview in its whole & "linkable" entirety, maybe we'll get a look at just what he really said.
Regards
I think you should work backwards. Determine cash flow needs in retirement, subtract the cash flow due SS and look at your portfolio to see if you can meet the cash flow needs with it and what risk level you might have to assume for it and see portfolio survival rate thru Monte Carlo simulation is acceptable. If the situation is not looking good one might have to delay retirement, take part time Job in Retirement or reduce costs and maybe if those are not possible downgrade expected life style.