Social Security As Your Fixed Income Allocation?

By Jun 7, 2010, 9:52 AM Author's Blog  

MarketWatch posted a sort of recap of some comments made recently by Jack Bogle. Most of it was probably familiar but there was one nugget in there I don’t recall seeing from him before.

For example, your Social Security investment, when you’re say 60 or 65, has a capitalized value of something like $300,000, and it’s going to continue to pay. It may pay a little bit less. I hope we can solve that problem, but it’s not going to go away.

“And so, if you have a $100,000 to invest, I don’t see why you would not put it all in stocks at that stage of your life. That would be 25% then in equities and 75% in effect fixed income with an inflation hedge [via Social Security]. It’s a good investment.”

So the sad thing is that most people don’t have $100,000 accumulated (depending on what you read the average 401k balance could be as low as $45,000). Also, I am leery of over reliance on social security and medicare. With those two points from me out of the way…the big picture concept is interesting.

If your social security is best thought of as a $300,000 fixed income portfolio (probably more like an annuity) what does that mean for the rest of your financial picture, specifically the allocation of assets you have in brokerage accounts?

The road to answering this question for yourself probably needs to start with understanding why you own fixed income at all. Over long periods of time there is a numerical argument for 100% equities–they grow (the last decade notwithstanding) and bonds mature in the future at their par value. Of course bonds can be used for speculation seeking capital gains, most people probably use bonds for income and offsetting equity volatility.

But if Bogle’s premise is correct then investors would need more equity exposure and would need to learn to live with more volatility. Someone who is 55 years old with $350,000 in a brokerage account targeting 60% in equities and 40% in bonds (this mix is well within the realm of normal) presumably has $250,000 in capitalized value from social security would think of their portfolio as being $600,000 targeting $360,000 in equities and $240,000 in fixed income. Since the brokerage account only has $350,000 this person will be slightly under their equity target.

So are you on board? Neither am I. Building a financial plan and investment portfolio requires an understanding of how the numbers should work and then implement an asset mix that lets the person be comfortable enough that they don’t panic sell. Since the capitalized value of social security cannot be seen it can be somewhat hazy. All an investor knows is how much their (in the context of this post) 100% equity portfolio is up or down over whatever period of time they care about.

A well constructed $350,000 100% equity portfolio will obviously be more volatile than a well constructed $350,000 60/40 portfolio and at a moment of maximum market puke down this investor is very unlikely to think about the capitalized value of their social security benefit.

Maybe I am wrong but people very rarely think about what it will be like for them during a real market panic which often leads to an emotional response when the panic comes. To the extent this is true, the concept set forth above by Bogle is likely a bad idea for a lot of people. Well unless they have some sort of objective trigger point for taking defensive action but of course he doesn’t believe in doing that.

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