Pensions and AA

[utrecht]

I typed out a long post last night trying to ask this question but it didnt sound right so i deleted it. Maybe I'll do better this time.

How does a pension affect your AA?

Lets say that you would be comfortable with a 60 / 40 split with no pension (60% stocks). You have the same risk tolerance but in this scenario, you have a pension will cover pretty much all of your expenses. What would you AA be under these conditions?

I can see one argument being that your pension should be considered the same as the fixed income / bond portion of your portfolio and you could go 100% stocks and be in good shape, but it seems to be that you would be able to safely with draw more money resulting in a higher income if you treated your portfolio and your pension as totally seperate entities.

If your main goal is to have the highest "safe" income in retirement, shouldnt you still have a 60 / 40 split and withdraw 4% of your portfolio and just add that to your pension to determine your monthly or yearly income?

 

[FinanceDude]

There was a study done quite some time ago that said a balanced portfolio gave you the highest return with the lowest amount of risk, it was the optimal balance on the "Efficient Frontier".

I just got a chart that has an 81 year history on it (1926-2007) that showed a balanced portfolio returned an average of 9.1% during that time frame. The AA was as follows:

10% Cash
30% Bonds
30% US Stocks
20% World Stocks (no US)
10% US Small Stocks

I will be doing this in retirement as I have no pension........

 

[MasterBlaster]

Some people have proposed that a pension can represent a "phantom" bond allocation. These people then increase their allocation to stocks.

Others think that these people are full of beans.

Do a search on "pensions and asset allocation" or "pensions and phantom bonds" and you'll find quite a bit.

I wonder though how the proponesnts of a phantom bond allocation see the world recently.

 

[FinanceDude]

Some people have proposed that a pension can represent a "phantom" bond allocation. These people then increase their allocation to stocks.

Others think that these people are full of beans.

Do a search on "pensions and asset allocation" or "pensions and phantom bonds" and you'll find quite a bit.

I wonder though how the proponesnts of a phantom bond allocation see the world recently.

If ALL your expenses were covered by a pension, why wouldn't you think that way? That's the way most COLA's pension folks I know think, not that its the correct way of thinking.........

 

[MasterBlaster]

If ALL your expenses were covered by a pension, why wouldn't you think that way? That's the way most COLA's pension folks I know think, not that its the correct way of thinking.........

Well just maybe you had plans for that "extra" money and wanted to see to it that some sort of relatively level income could be acheived with the additional money. If you have the nestegg in stocks alone it just may be a pretty wild ride.

It isn't necesary to bet the farm on any assets that aren't nailed down.

 

[Cb]

I wonder though how the proponents of a phantom bond allocation see the world recently.

Well, for what it's worth we own our home and are expecting SSI & pension income that will cover just over half of our expenses after age 62. We've now rebalanced twice to maintain our 85/15 Stock/Bond S&D portfolio.

Cb O0

 

[Nords]

How does a pension affect your AA?
I can see one argument being that your pension should be considered the same as the fixed income / bond portion of your portfolio and you could go 100% stocks and be in good shape, but it seems to be that you would be able to safely with draw more money resulting in a higher income if you treated your portfolio and your pension as totally seperate entities.

This reminds me of the question: "Is a pension part of your asset allocation, and if so then what part?"

A federal govt pension might be considered the equivalent of I bonds while a GM pension might be considered the equivalent of C- junk bonds.

If ALL your expenses were covered by a pension, why wouldn't you think that way?

This reminds me of the question: "If you don't need it, how should you invest it?" The ER portfolio could be considered a rainy-day fund or one's personal long-term care insurance. Or it could be time to donate it to charity, fund a trust, buy that Class A RV, help your brother-in-law's startup business, join an angel-investing group, or take it to Vegas.

That's the way most COLA's pension folks I know think, not that its the correct way of thinking.........

Flippant answers aside, what's the correct way of thinking?

If a COLA pension can be replicated by a Vanguard annuity (depending on who's backing it these days) then how would an annuity affect an asset allocation?

While I agree that Bernstein has found that 10-20% bonds have reduced volatility and raised returns along the efficient frontier, that study doesn't include foreign investments (both equities & bonds) or just the dividend-paying stock sector. It doesn't include commodities or REITs or rental real estate. Personally I'd like to see an equivalent study that sets bonds at zero and substitutes cash for the 10-20%. I suspect that recency and changing correlations may have affected all of our "studies", and that none of the old stuff is valid alongside the market's added recent performance.

My COLA pension supplies about half of our spending. Lately our rental income has covered a large chunk of the rest, although that's much less reliable. In 13 years I can reasonably predict that spouse's pension will cover whatever's left. In the meantime we could put our ER portfolio in a 13-year CD ladder, or we could invest it in the equity market-- especially in dividend-paying equities. Yet somehow a portfolio's equity tilt (to counterbalance a pension) is deemed too risky?

To answer the original question, I think that a pension should be considered an equivalent asset class and applied to an overall asset allocation. Doing so helps ERs assess their volatility tolerance and counter inflation with a higher allocation to equities (or other assets). And if the volatility is still too high, then fer gosh sakes' diversify into less-volatile assets.

 

[utrecht]

If ALL your expenses were covered by a pension, why wouldn't you think that way? That's the way most COLA's pension folks I know think, not that its the correct way of thinking.........

Because Im not interested in only covering my basic expenses. Im more interested in setting up my AA so that I can safely withdraw the most money possible and after finding out how much money that it, I can set a budget with lots of room for travel, and other extras.

 

[DoubleDown]

There was a study done quite some time ago that said a balanced portfolio gave you the highest return with the lowest amount of risk, it was the optimal balance on the "Efficient Frontier".

I just got a chart that has an 81 year history on it (1926-2007) that showed a balanced portfolio returned an average of 9.1% during that time frame. The AA was as follows:

10% Cash
30% Bonds
30% US Stocks
20% World Stocks (no US)
10% US Small Stocks

I will be doing this in retirement as I have no pension........

This portfolio sounds like the Vanguard Star (VGSTX) Fund.

 

[DoubleDown]

I typed out a long post last night trying to ask this question but it didnt sound right so i deleted it. Maybe I'll do better this time.

How does a pension affect your AA?

Lets say that you would be comfortable with a 60 / 40 split with no pension (60% stocks). You have the same risk tolerance but in this scenario, you have a pension will cover pretty much all of your expenses. What would you AA be under these conditions?

I can see one argument being that your pension should be considered the same as the fixed income / bond portion of your portfolio and you could go 100% stocks and be in good shape, but it seems to be that you would be able to safely with draw more money resulting in a higher income if you treated your portfolio and your pension as totally seperate entities.

If your main goal is to have the highest "safe" income in retirement, shouldnt you still have a 60 / 40 split and withdraw 4% of your portfolio and just add that to your pension to determine your monthly or yearly income?

I am in a similar situation. At retirement I will have a government COLAd pension that will take care of my expenses. In the near future I will create a balanced (60/40) taxable portfolio set up to supplement my spending money and also add in the expense of rolling over my 401k monies to a Roth IRA. I will then yearly take 4-5% of the taxable account balance. I'm thinking of taking the easy way out and put all of this taxable $ in the Vanguard Star fund and take dividends and capital gains in cash then just sell shares when needed to make my 4-5% target. Good luck to you.

 

[Goonie]

Since I have a cola'd pension that covers all of my expenses. My net income from the pension is just shy of 92% of what my current net paycheck would be, had I not retired....that includes the pay raises that have gone into effect since I FIRE'd. (the pension net amount is after taxes and health insurance premium deductions)

So since the pension still fully covers everything and anything that I need or want, my investment risk tolerance is quite high.....as in "I have it IF I ever need it, but chance are I won't ever need it".....so it's just there as "mad money" or "money for a rainy day". In order to make everything super simple for myself, I moved a vast majority of my retirement savings into two target retirement funds....a 2020 that is 78% stock and 22% fixed & short term income.....and a 2030 that is 89.5% stock and 10.5% fixed income. The rest is in either a MM or in CD's......both a minor portion of my retirement investments. I'm looking to keep it there for the long haul.....at minimum 10-12 years....most likely much longer. So even though the [-]toilet flushed[/-] market stinks, I'm still OK with my AA.....and pension!

 

[jIMOh]

You cannot rebalance the pension if stocks decline or bonds go up. I would at minimum advise bond or cash position if you have a pension.

So 80-20 or 75-25 for example. This way you can rebalance and improve IRR over long term with less volatility.

 

[MasterBlaster]

You cannot rebalance the pension if stocks decline or bonds go up. I would at minimum advise bond or cash position if you have a pension.

So 80-20 or 75-25 for example. This way you can rebalance and improve IRR over long term with less volatility.

The "phantom pension" bond theory goes like this...

suppose you had a $8k pension with inflation increases.

Well lets say you have an additional $800k savings.

traditionally one might keep (for example) 60 percent of the nestegg in bonds and 40 percent in equities - the 60/40 asset allocation.

But if we count the pension as bonds then you might say it has a net present value of 25X payout or $200k (ie 25 times $8k).

In that case you could count the "phantom bond" as $200k then allocate another $400 k to actual bonds and leave the other $400k in equities.

That leaves the original 60/40 split. Note that should the market for bonds and/or equities rise or fall that you still have plenty of money to re-balance.

The problem lies with larger pensions. In that case the pension (and associated phantom bonds) could represent a way too big share of the portfolio. In that case you'll just have to decide if phantom bonds are for you and deal with the issue of not being able to re-balance.

On the other hand if you do have a large pension, then the traditional 60/40 split on the nestegg just may be too conservative.

Anyway, it's something to think about... This gets kind of involved and goes way beyond what I am willing to post here. Do a search as suggested above and you'll get lots of information and things to ponder.

 

[deserat]

Utrecht - you bring up an interesting question and one that my husband and I have discussed. He is eligible for a government COLA'd pension early in his life (military). I am eligible for a COLA'd smaller government pension (military reserves) at age 60. I also will have a small pension from an employer I worked for for 14 years at age 65. His tolerance for risk is much higher than mine as I need to supplement my pension income with other financial vehicles if I wish to retire earlier than 60 and with a lifestyle that I am comfortable with. When we married, he had no real assets, while I did - his eggs had been placed in a different basket than mine.

He decided to accept my risk level and in light of what has happened in the financial world recently, he is delighted at my approach. I have 'buckets' of money that are sacrosanct and are to be kept as conservative as possible (money markets and cash) - the rest gets to ride in an 80/20 (equities/bonds) allocation. The after tax funds (to cover our gap years between his pension and mine) are only needed for 10 years at the most; the tax deferred may never be needed. The roof will be paid for when we are retired. His pension will cover 60%/80% of living expenses, with the rest coming from after tax funds.

So, to answer your question, the value of the pension is counted as part of covering the lifestyle costs and is used in determining the amount of risk that can be taken for the rest of the financial vehicles.

 

[W2R]

There was a study done quite some time ago that said a balanced portfolio gave you the highest return with the lowest amount of risk, it was the optimal balance on the "Efficient Frontier".

I just got a chart that has an 81 year history on it (1926-2007) that showed a balanced portfolio returned an average of 9.1% during that time frame. The AA was as follows:

10% Cash
30% Bonds
30% US Stocks
20% World Stocks (no US)
10% US Small Stocks

I will be doing this in retirement as I have no pension........

60% stocks in retirement? After this month? You are brave.

 

[Dawg52]

60% stocks in retirement? After this month? You are brave.

He must have a prescription for the medication I'm taking.

 

[W2R]

He must have a prescription for the medication I'm taking.

Prescribed by Dr. Jim Beam, I suppose...

 

[Homebrew]

I was thinking of posting a similar question, but this thread seems like an appropriate place to bring this up....

If ALL your expenses are covered with a pension, then one end of the spectrum is that you can AFFORD to take as much risk as you want (i.e. 100% equities, etc) because if you lose it, you don't really need it; and the other end of the spectrum is that you don't HAVE to take any risk (i.e. CDs, I-bonds, etc.) because you don't need to make a killing. I suppose it's a personal choice at this point.

Personally, I think that if the pension covers your expenses, then you are in fantastic shape compared to most people who likely have to take on some risk to meet retirements goals. If it were me, I'd decide what AA let's me sleep REALLY good at night when the market is bad.

My two cents.....

 

[unclemick]

Pssst Wellesley - or to paraphrase that great whiz Yogi Berra - dividends and interest are almost as good as real money.

Don't take me too serious theory wise as I am lefthanded, test INTJ, and firmly believe sanity is overrated.

income stream wise Not portfolio size wise:
core budget:
24% - early SS
16% - non cola pension

grey area: pets, cable, etc
10% - taxible Norwegian widow dividends

variable budget: exotic travel, new cars, etc
50% - 3% SEC yield to 5% of portfolio range

In todays $ I still believe there is enough residual cheap bastard in me to live on SS and non cola pension in hard times mode - ie on paper 40% of my good times mode.

Since I want 20 to 30 yrs optimistically out of the variable portfolio - I picked Target 2015 a pretty hot rod 65/35ish(3% yield) to start.

Now if I needed more cash flow or had a smaller portfolio over and above a pension/SS/dast I say annuity - then I would drift handgrenade wise more toward Wellesley - the ultimate being the world of maybe Inflation indexed securities.

Note - I am leaving open the damping SD/ RMD and or spend down principle in your old age questions till I get really old say 70 or 80 - being a young 65.

heh heh heh - I read the MPT stuff - but I always start with income streams and then think asset classes/mix ratios. In the early days of this forum I tryed some of the methods of converting income streams to fixed asset amounts and then working up asset ratios/expected growth and plugging into retirement calcualtors - with the resulting range making my head hurt.

I'm just an old dividend/income stream fogy at heart.

 

[headingout]

Bernstein (Four Pillars p.278-279) argues that pensions (and social security) should be factored into AA.

I agree, did some research as suggested here into how to compute a PV of my SS, and implemented that change in my AA at the start of this year.

That let me rebalance more "bonds" into equities as the market has gone down. Do I wish I waited longer? Sure, but that's hindsight. I still think this is a valid approach. If your pension and/or social security isn't equivalent to a bond, what is it? It is fixed income that you can rely on......

Caveat: to sleep at night I compute my AA both with and without my SS and compare both of those AA's to fairly conservative targets. I still want to see a certain percent of "non-phantom" bonds to rest well.....

 

[grumpy]

60% stocks in retirement? After this month? You are brave.

I have been retired for four years. During that time I have maintained an allocation to equities of 70 to 75% (that's only 35 to 40% considering the "phantom bonds" that my pension represents). Of course my net worth is down 32% since the start of the year but I'm not losing sleep over it. The drop in the markets has reduced my stock allocation to around 65%. I have no source of "real bonds" to reallocate into stocks so I have been gradually moving some funds from the TSP G fund into the C and I funds.

 

[tightasadrum]

Personally I'd like to see an equivalent study that sets bonds at zero and substitutes cash for the 10-20%. I suspect that recency and changing correlations may have affected all of our "studies", and that none of the old stuff is valid alongside the market's added recent performance.

I've been wondering about this very thing. Trouble is, we won't know until the fat lady has finally sung her aria. By then, all financial AA decisions, and most of my investing life, will be about over. Let's just hope that it's not too much different this time.

 

[tightasadrum]

heh heh heh - I read the MPT stuff - but I always start with income streams and then think asset classes/mix ratios. In the early days of this forum I tryed some of the methods of converting income streams to fixed asset amounts and then working up asset ratios/expected growth and plugging into retirement calcualtors - with the resulting range making my head hurt.

I'm just an old dividend/income stream fogy at heart.

Simple is good. unclemick, I like the way you think.

 

[tightasadrum]

I discovered tonight after one of those semi-explosive, 30+ years married, say-what-is-really-on-your-mind-moments with DW that she's been freaking out over this market. She had it in her mind that we were doomed to live in squalor for the balance of our years, never to realize the use of all the savings and investments "after years of delaying gratification." Geez. I really haven't felt that deprived. I happened to mention that I lost a few thou in WuMu when it tanked. She wanted me to put everything is CD's that are safe.

So I sat down with her and showed her the assets, by type; the incomes, by source; how assets are allocated, for diversity; and the purpose of some higher-risk investments to grow the kitty and try to keep up with the inflation monster that is certainly coming. It's not like I've been hiding this or something, but hey, nobody asked! I think she's reassured. She's a lot smarter than I am, so this one took me by surprise.

Now I'M all churned up. I hope this market recovers in the next few years, or I'm toast.

 

[Nords]

Now I'M all churned up. I hope this market recovers in the next few years, or I'm toast.

You have to make sure that you're worth more alive than dead...