Moving to 100% in Stocks
I decided to move our portfolio into 100% stocks. But it’s not a scary as it might sound.
I’ve been maintaining a 88/12 stock/bond asset allocation for awhile now.
But we have a few components to our portfolio that haven’t been included. I want to include them for a more holistic picture.
Pension Plan. The first is my husband’s pension. (Mine has since been converted to my IRA as I took a lump sum when I left my job). It has grown significantly over the last few years since it’s formula based (and because he earns a full year of service working just 25 hours per week), to the point where it should be included in the management of our portfolio.
Social Security. Whether or not you believe Social Security will be around in it’s entirety is a whole other can of worms, but there will be an impact to your asset allocation. I’ve always ignored Social Security to this point, but feel it does at least deserve the analysis.
Phantom Bond Allocation
I’ve been researching the “phantom bond” allocation and decided that I would convert the pension into present value and include it as a bond portion in our portfolio. I used to ignore the pensions since I can’t control them, but I’ve always felt uncomfortable with that. What convinced me, was when I read a thread at the early retirement forum where haha pointed out that this logic is unassailable; I’ve started to evolve my asset allocation.
I made a shocking discovery, we’re significantly overweighting our bond portion of our portolio. If you convert the pension and our social security to net present value (and discount the Social Security based on the risk of Social Security actually being around then), we’re more than double overweighting our bond portion.
Example Phantom Bond Allocation
Here’s a quick example. A $50,000 pension per year is worth roughly $700,000 in a future lump sum. If you discount it today from 20 years at 3%, it makes the NPV about $390,000.
Let’s say you originally had a $500k portfolio and you were doing a 50/50 stock/bond split. If you include the npv of the pension, all of a sudden you have 28/72 stock/bond split! It’s much more conservative than the 50/50 split you were targeting.
How to Convert Income Streams
To convert income steams to npv, I first calculated what the monthly income stream would be if you purchased an equivalent annuity in the future. Or a quick rule of thumb is to take the annual income stream times 14 to get a rough estimate.
If you don’t know the current income stream of your Social Security, you can use the SS calculator. (I further discounted our Social Security estimates to account for the changes I believe will come in the future.)
Once you know the lump sum amount in the future, you can convert it to net present value.
Going 100% into Stocks
So I’m selling our tips and bonds, and going 100% stocks. Of course we still hold more than enough bonds with the phantom bond allocation to maintain a portfolio that is even more conservative than we would like.
It will mean that the accounts I can manage are more volatile, but I’ll have to remind myself that the overall picture is what counts. I’m still going to work on going back and inputting the npv’s of the pension during the dip in 2008/2009 to see how much it softened the blow.
Now that I’ve accounted for the phantom bonds, the next step in my evolving portfolio is to try to find a way to include real estate and business investments so I can manage our entire net worth as one big picture.
Do you include pension npv in your portfolio?
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I think that your analysis is great, but I had a couple of comments. First, it looks like you may be valuing the SS payments as an immediate annuity without inflation adjustment – but SS does include an inflation adjustment, so the comparative annuity value would be even higher. Also, SS may actually be providing more than one annuity depending on how you claim it – for example, if you claim on your husband’s work record and then also claim spousal benefits.
Second, you mentioned the risk of loss of Social Security, but there is often a risk of loss associated with pensions, too. Companies don’t last forever, and even getting taken over by the Pension Guarantee Fund may not provide you with the expected pension benefits.
Third, the SS calculator may tend to overestimate benefits, especially for the younger people, because it typically assumes that you will continue working and paying SS tax at the same rate. However, that’s not necessarily true.
Overall, I very much agree with your approach. I typically include SS when I consider my portfolio. However, 1) I only value SS at the actual accumulated benefit based on my work record to date, 2) I value the annuity including the inflation adjustment, and 3) I assume that my spouse will also take her spousal annuity and include that as well. I don’t get any pension, so I have nothing to include there.
Thanks for the feedback! It’s very helpful as I’m working through these calculations. Let’s work though each of your points.
SS Inflation Adjustment
You are right, I was valuing the SS payments without an inflation adjustment, so I’ll go back and recalculate it to find the higher amount.
Risk to Pension
Thanks for pointing out the PBGC. It’s helpful for those who have lost their pensions. I think I’ll add a risk factor to discount my husband’s pension (although I would think it won’t be as risky as a private business since he works for a Big Ten University) just in case his pension is frozen or the state goes bankrupt. Good catch!
I should specify that I used the secondary SS calculator limiting it to the actual benefits to date. For anyone looking to do the calculations, once you enter your information online, you can select “Create Additional Scenarios” which brings you to the estimator for valuing SS based on the work record to date, by specifying your current age. This is an important distinction since the annual statement that comes in the mail also includes the benefits if you were to keep working. Thanks for reminding me to point out the difference.
SS for Spouses
Where I’m going to have to do some more research is in the area of the spousal benefit. From what I understand, spouses are entitled to half of their spouses SS benefit, but that is in place of their own, right?
The reason that I ask is because my benefit to date is almost equal (if not slightly larger) than my husbands benefit. So if we were to elect them today (assuming we were old enough), I would use my own and he would use his own, and we would forfeit any spousal benefits, right?
As of right now, I’m valuing both social security payments independently, but I realize that could change in the future.
Thanks for all the helpful discussion points. It helps to talk this through to make sure I’m doing the calculations correctly!
100% into stocks is a scary thing to hear when we’ve seen so many people who planned on retiring soon have to put off retirement while they waiting for their stock portfolios to play catch up.
I have been thinking about doing this as well, or even taking a leveraged position on stocks. Have you read Lifecycle Investing by Ian Ayres and Barry Nalebuff? This is the exact concept that they promote.
Nick – When Madison considers the NPV of her husband’s pension and the SS, these benefits are typically quite large – think hundreds of thousands. Also, there is the equity in her home and other businesses – which is probably hundreds of thousands more. Taking a conservative $500K valuation for all of that, then even if Madison had $1M that she was moving into stocks, then she would still only really have 66% of her net worth in stocks. However, more realistically, she’s probably only really shifting her total net worth portfolio by about 20-30%.
The pensions can really be a nice backstop in situations like this – especially when the pension alone is enough to pay for expenses in retirement, as is often the case. Once that takes place, then the remaing “portfolio” can be a lot more risk tolerant.