Tim,
A great OP with good questions. I can't add much to the great advice/points-to-ponder you've been given by Nords and others. But, here goes:
-- I'm in almost the exact situation you anticipate you'll be in when you retire--our retirement is based on the USAF retirement check every month and the money we saved. I retired from the USAF about 5 years ago, so I'm still relatively new to this stuff. My AA is approx 75% equities, 10% cash, and 15% bonds. Why are we so heavy into stocks?
--- It's
not that we are trying to get rich. As you have observed, we don't need to hit a home run, we just need to consistently stay ahead of inflation. You've got a long time horizon ahead of you, and stocks have a long track record of providing the type of growth (not steady growth, but growth) that stays ahead of inflation to a degree that will allow a reasonable withdrawal rate (3-4%).
--- Because we can. As I see it, the relative stability of our pension takes the place of a big chunk of cash/bonds in our AA. If the market crashes and we lost every nickel, I'd cry a lot but we could get by. We'd eat a lot of beans and bread, but we could do it. Conversely, if Uncle Sam gave me that retirement pay as a lump sum, I'd probably have to invest it in something with a very stable value (even at lower returns) to get the same stability. While pay in the military has gotten a lot better than it was 40 years ago, you still won't get rich, and pay lags the civilian sector in most areas. Your pension helps compensate for this. You'd probably have more money to plunk into a 401K if you worked in the civilian market. And, you'd need to put more of it in conservative investments because you'd lack the COLA'd retirement pay. In my case I believed that I could afford to take the risk of being in stocks, and that I needed to do it.
--- To diversify risk: There's a potential that the government is gonna owe a lot of people a lot of things over the coming decades. Taxes are probably going to go up. Some benefits are going to go down. So, if the promises aren't kept in their entirety, it's good to have a robust alternate source of monthly income. If you "play it safe" in your earning years and give up the higher yields historically offered by stocks, you may not be able to generate that make-up monthly income. I agree that stocks don't appear to be cheap right now--and you can try your hand at market timing if you like. It didn't work for me, ad it doesn't work for most people.
As Gumby mentioned, your ideas on how much cash you'll need may change as you get older. Mine did. Kids, college, hobbies, house, travel. I've still got one foot in the rat race as a result. We
could get by without the extra income, but we choose not to. If I'd selected a more conservative investment philosophy over the last 25 years, we'd have fewer options.
Put the money in good investments and don't obsess over it. I scarcely looked at my stash over a period of 20 years, I just did my annual rebalancing. All the money came out via payroll deduction and I never missed it and we barely thought about it. Lots of dps in values and meteoric rises--just like the book said we should expect. If I'd tried to time things and make daily adjustments I'm virtually sure we'd be worse off now.
I realize that some of these points contradict others (e.g. if the government might not keep their promises on my pension, doesn't that mean I should take LESS risk with my nest egg?). I don't attribute this to faulty reasoning, but to a valuable ability to diversify my logic strands so that they have negative correlation with each other.
