When considering your investment strategy, asset allocation is a critical aspect. This involves determining the portion of your portfolio allocated to different asset classes, such as stocks and bonds, which is largely influenced by your age and risk tolerance.
Typically, in youth, individuals can afford to weather market fluctuations and thus lean towards riskier yet potentially higher yielding investments like stocks. As one ages, it’s advisable to adjust this mix, reducing exposure to stocks and increasing allocation to more stable assets like bonds.
Your risk tolerance is also a key factor. Those comfortable with risk may favor a stock-heavy portfolio, while others inclined towards safety may opt for a more conservative mix.
However, a less common consideration arises: What if you could assign a present value to your future Social Security benefits and integrate this into your investment portfolio? This concept, endorsed by investing luminary Jack Bogle, could significantly alter your investment approach.
Let’s illustrate with an example. Suppose your investments total $450,000, with an optimal asset allocation of 60% stocks and 40% bonds, equating to $270,000 in stocks and $180,000 in bonds.
Additionally, let’s presume your projected Social Security benefits amount to $1,250 monthly, equating to $15,000 annually, commencing at age 67 (you can ascertain your estimated benefits by creating an account on the Social Security Administration’s website). This scenario necessitates estimating your lifespan; for instance, let’s assume you’ll live another 20 years after initiating Social Security benefits.
Bogle proposes valuing your portfolio at $750,000, comprising your actual investments plus the assumed future Social Security benefits ($15,000 annually for 20 years). While there are various methods to compute the present value of these benefits, a straightforward approach is multiplying the annual estimated benefit by the expected years of receipt.
With this adjusted portfolio, applying a 60/40 allocation suggests investing $450,000 in stocks and $300,000 in bonds. Since Social Security represents a near-certain benefit akin to a bond, Bogle suggests treating it as such, enabling full investment of the actual $450,000 portfolio into stocks.
What Risks Should You Consider?
Advocates of this concept, like Bogle, highlight the potential for significant portfolio growth through a more aggressive investment strategy. Historically, stocks have indeed outperformed bonds, supporting this notion in theory.
However, embracing this approach entails accepting considerably higher risk than your current stance and enduring potentially uncomfortable levels of volatility, especially in later years. Imagine being 65, with your entire retirement portfolio in equities, enduring a market downturn akin to 2008, and witnessing a 50% loss.
Additionally, suppose leaving an inheritance holds significance for you. In the event of a market downturn similar to 2008 during your 60s or 70s, coupled with an unforeseen decrease in lifespan from your assumed age of 87, your actual portfolio could suffer a substantial hit, leaving little behind.
What about the $300,000 of anticipated Social Security benefits in your portfolio? Upon your demise, their value diminishes to zero. Does this sit well with you?
Furthermore, there’s the uncertainty surrounding the future of Social Security itself. While its complete dissolution seems improbable, the likelihood of benefit reductions through means testing based on household income is more conceivable. The current influx of funds from workers might not sustain full payouts indefinitely.
This strategy is not for the risk-averse. Even those with high risk tolerance should cautiously incorporate future Social Security benefits into their asset allocation, possibly only a fraction thereof. For most individuals, given the heightened stress and uncertainty this approach entails, particularly during a phase of life where peace of mind is paramount, it’s likely not advisable.
