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Investing Specialists

What Role Does Social Security Play in Readers' Asset Allocation Decisions?

Many Morningstar readers think of Social Security as income, not as an asset.

This week is Morningstar.com's Retirement Matters Week, where each day we take a deep dive into portfolio planning issues that retirees face. One such challenge is determining what role Social Security will play in portfolio planning. There are different schools of thought on this topic. For one, Vanguard founder Jack Bogle has expressed the opinion that people ought to consider Social Security as an asset (akin to a fixed-income allocation), and failing to account for it can result in potentially underweighting their equity allocation. 

Others, meanwhile, take objection to the idea of computing a "present value lump sum" for Social Security's income stream, as Social Security is not a financial asset that can be bought, sold, or rebalanced. Therefore, they consider it separately from their investment assets, and do not include it in their asset allocation.

This week, we asked readers how Social Security factors into their asset allocation decisions. Most commonly, readers expressed the view that Social Security is an income stream, not an asset. Though some readers said they do calculate the present value of Social Security and factor it in their asset allocations, most said they do not, thinking of the future income stream instead as a reduction in future expenses or as "longevity insurance." 

To read the full thread and weigh in yourself, please click here. The following is a summary of the responses.

'Social Security is income, not an asset.' McMontana
Similar to many other readers, yogibearbull considers Social Security as an income stream. This reader explains that the "income-gap approach" is a sensible way to incorporate Social Security into your in-retirement portfolio: "Add up all income, from pension, annuities, Social Security. Add up all expenses. Income gap is all expenses minus all income. Then just manage the portfolio to support that income gap." This reader adds, "What if the income-gap is negative? Well, when people are working, the income is negative, and it is called savings. So, don't go overboard with equities just because of this."

"I subtract the amount of Social Security payouts from my retirement income needs, just as I add taxes and subtract pension payments. But, the fact that some of this adjustment comes from Social Security has absolutely no effect on the way I allocate my assets to produce the resulting income," said Darwinian. "It is an error to regard Social Security as somehow 'bond-like.' If you need emergency income, you can sell bonds. Try that with your Social Security. The government will not be amenable." 

"I try to cover my expense estimate with income from the investment portfolio plus Social Security, while attempting, at minimum, to avoid depleting the portfolio's value," said McMontana. "Sure, anyone who wants to can calculate a figure for the Social Security principal and then stick that in a fixed-income sleeve for a sort of overview, if they think it will be helpful to them. I just don't see a lot of value in doing it."

"I do not include Social Security as part of my asset allocation," said bgstuhan. "The purpose of my retirement investments is to generate retirement income.  Social Security generates inflation-adjusted retirement income and so I reduce anticipated retirement expenses (which are also inflation-adjusted) by anticipated Social Security income payments."

Dennis said: "I used to waste time to figure the principal value of Social Security and pension to fit into the fixed-income sleeve of my portfolio, but the value of those two changed with interest rates and the ratios of stocks to fixed income and cash all seemed so arbitrary, not fitting one's own situation in terms of longevity expectations, future inheritances and those to benefit upon my death. I now consider those income streams as an offset of my expenses."

"What is Social Security's role in my asset allocation? None," said FedEngineer. "As others have said, I see it as potential income, and I consider it in the same light that I view a couple of small potential pensions from a couple of previous employers."

"Social Security is an inflation indexed annuity, and we consider it as such. It has influenced our decisions and calculations on whether we want any other annuities (we decided no) and on how much we will need to take out of our investments for spending money each year. That, rather than worrying about whether to include its guessed present value in our fixed income portfolio count, is how it has had effects on our allocations," said retiredgary.

'[Social Security] helps me take a little bit of extra risk.' Twolves
Meanwhile, some posters, whether or not they consider Social Security as part of their asset allocation frameworks, noted that the income they receive from it had allowed them to employ a more equity-heavy asset allocation mix.

Juris2 said: "I do not directly or formally account for Social Security in my asset allocation plan. But having Social Security income makes me a tad more comfortable with risk in my investments as well as less inclined toward annuitization to support my retirement."

"We consider Social Security part of our income and along with our pensions; it allows us to be more aggressive in our investing than our age would dictate," said Tuffs43.

Mickeg modeled several scenarios for the net present value of Social Security benefits, and doing so provided this reader with some reassurance about an "unusually high allocation to equities." "If I plotted up my total assets on a pie chart, by adding Social Security as another slice of pie, that would make my equities a smaller slice on that pie chart. Since I can treat Social Security as a nearly risk-free asset, that does reduce the level of my total risk when I offset risk from equities with nearly risk-free Social Security."

"I'm several years away from claiming Social Security, but my inclination is to say that it will not affect my allocation decisions much," said FingerlakesGuy. "That said, it is possible that since I assume most, if not all of my needs will be met by my pension and Social Security, I may not decrease my allocation balance from equities to bonds quite as much as I would normally as I age."

'Social Security is equivalent to having a $500,000 asset.'EngineerView
Finally, some respondents said that they do factor Social Security into their asset allocation, as cash or bond assets.

"As Social Security provides an income independent of the vagaries of the stock market, I regard it as a cash asset," said EngineerView. "To assess the cash asset's value, let's assume you derive $20,000/year from Social Security. Using the 4% rule of asset withdrawal, that would imply that your Social Security is equivalent to having a $500,000 asset."

"I calculate it like EngineerView: $20,000/year/4% safe withdrawal rate = $500,000 equivalent bond holding," said ThePill. "As far as asset allocation I only recognize it as if it was a $250,000 bond." 

"We're not U.S. Americans, but both of us are eligible for our country's Social Security pension," said galeno. "It is 11% of our asset allocation balance sheet counted as 'bonds'."

"If I impute a value to my income stream from Social Security using a 4% rate, then add that amount to the bond side of my portfolio, that brings my allocation to right about 50-50, which seems about right," said Flexible3.

Gaylonlowery said: "We agree with EngineerView and look at Social Security as though it is a million-dollar annuity yielding 4.6% in cash flow. This covers approximately 34% of our monthly cash requirements is a great assist to our investment portfolio."