Determining Your Investment Strategy: Should You Factor Your Social Security Benefits into the Equation?
When crafting your investment plan, a crucial consideration is asset allocation—the distribution of your portfolio among different asset classes like stocks and bonds. The ideal allocation is heavily influenced by factors such as your age and tolerance for risk.
For the younger investor, there’s more leeway to weather market volatility, making a higher allocation to riskier yet potentially more lucrative investments like stocks advisable. However, as you age, a shift towards a more conservative mix, with less exposure to stocks and more to stable assets like bonds, is prudent.
Your personal risk appetite also guides this decision. Those comfortable with risk might lean towards a stock-heavy portfolio, while others preferring safety may opt for a more conservative mix.
Now, let’s delve into a thought-provoking concept: what if you could assign a present value to your future Social Security benefits and include it in your current investment portfolio? This adjustment, advocated by investment luminary Jack Bogle, would significantly alter your investment approach.
Consider this scenario: Your investments stand at $450,000, with an optimal allocation of 60% stocks and 40% bonds, translating to $270,000 in stocks and $180,000 in bonds.
Adding estimated Social Security benefits of $1,250 per month (commencing at age 67) for a projected 20-year span, and assuming a life expectancy, you would value your portfolio at $750,000. This figure encompasses $450,000 of actual investments and $300,000 representing future Social Security benefits.
Applying the 60/40 allocation to this adjusted portfolio suggests an optimal mix of $450,000 in stocks and $300,000 in bonds. Bogle’s perspective considers Social Security akin to a conservative asset, akin to a bond rather than a stock, affording you the freedom to invest your entire $450,000 portfolio in stocks.
What Risks Should You Consider?
Advocates like Bogle highlight the potential for significant portfolio growth with a more aggressive investment strategy enabled by factoring in future Social Security benefits. Historically, stocks have outpaced bonds, theoretically supporting this notion.
Yet, this approach also entails significantly heightened risk and increased volatility, particularly as you age. Imagine reaching 65 with your entire retirement portfolio in equities, enduring a market downturn akin to 2008, and facing a 50% loss.
Moreover, if leaving an inheritance matters to you, a market downturn during your later years could disrupt that plan. If your life expectancy assumption proves inaccurate, only your actual portfolio, now halved, would remain for heirs.
Consider too the nature of Social Security benefits: upon your death, their value diminishes to zero. Are you comfortable with this aspect?
Another concern is the uncertainty surrounding Social Security’s future. While its complete dissolution seems unlikely, reduced benefits based on household income, or means testing, is plausible. Current contributions may prove insufficient to sustain full benefits indefinitely.
This strategy isn’t for the risk-averse. Even those with high risk tolerance should cautiously incorporate future Social Security benefits into asset allocation, perhaps only in part.
For most, the added stress and uncertainty this approach entails, particularly during retirement when peace of mind is paramount, likely outweigh any potential benefits.
