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treating COLA'd pension as bond allocation??
Old 10-29-2007, 10:27 PM   #1
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treating COLA'd pension as bond allocation??

Hello,
I'm still sorting through quite a bit of the info archived on this site, and recently obtained ESRbobs latest books WLLM(2007) and the workbook. I'm currently reading WLLM with great interest, but have some questions regarding the RIP allocations and the pertinence to my specific situation;

I'm in an accumulation (albiet late) phase and intend to be a bit more aggressive in building the nest egg...I'm still new to the ER/ESR concept but since I've actually put a focus on it and done some introspection, we've made good effort put some personal lifestyle changes into action on the homefront.

In my attempt to AA in a logical manner I initially intended to run an 80/20 equity/bond split - with those percentages further sub-divided among the classes as many here have mentioned and also put out in much of the recommended literature.

It has been suggested to treat my military pension as if they were bonds - --Is this to say I should probably be 100% in stocks for now and treat the pension as an equivalent of $900,000 in bonds ($36k x25)?? I am receiving my 2nd check in a couple days and miscalc'd the pension in my intro post since I didn't take VAcomp/CRSC into the amount I'm getting which is approx $1k month higher - which seems to make a significant difference.
--Am I looking at this pension/bond issue from the wrong angle??

Any suggestions from experience on determining AA of portfolio while taking the pension in account would be greatly appreciated...my initial instinct was to basically go with the RIP recommendations using only the equity breakdown for my current/foreseeable contributions - being a newbie on this front though I know instinct is not the way to go:confused:

I have some 401k questions I'll save for later - suffice to say I thought it was right to blindly max out a tax deferred acct, but after reading some folks only contribute to the point they are matched then tier savings toward IRA and/or taxable accounts I was a little baffled and need to crack that code...after reading some of the posts I took a look at the 'fees' in our 401k and am not happy about it...

salud,
1-0
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Old 10-29-2007, 10:41 PM   #2
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I would just subtract the pension from your required income. You can't rebalance a pension versus stocks, so a pension is not like bonds. However, if the pension pretty well covers your basic expenses you could certainly get by with a small to none allocation to bonds.

Dan
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Old 10-30-2007, 07:58 AM   #3
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I treat my expected Gov't COLA pension as a bond fund and know of others who do the same for risk allocation purposes regarding liquid assets available to them in retirement. So, we are almost completely invested in equities in all of our tax deferred retirement accounts, TSP, 401Ks, IRAs, Simple 401Ks. Our liquid taxable accounts are principally designed for emergencies and include some individual stocks and cash/CDs. I think, however, if you treat your pension as a bond fund for risk allocation purposes for your remaining assets, you should be careful in how you value that pension. Your pension is a government-backed, life-time annuity with some surivorship benefits, in my case, the value of the annuity to my surviving spouse could be anywhere from 55% to 1% of my pension, depending on how we elect survivor benefits. As we age, I will take into account that my wife will survive me -- it's a good chance that she will -- and thus, value the pension/bond fund appropriately and perhaps take less risk in equities. I sense this intuitively but I think I will need some professional help to put together the numbers and plan accordingly. Right now, I'm content with making very crude approximations of asset allocations.
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Old 10-30-2007, 08:26 AM   #4
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Here is a lengthy discussion of this topic:

Morningstar Discuss

also check out the linked thread:

Morningstar Discuss

In a nutshell...Some people like to value the cash flow out of a pension in terms of its present value and use that present value as a bond equivalent. You can read all about the finer details in the links above.
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Old 10-30-2007, 08:58 AM   #5
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Thanks for the links MasterB. Great discussion and coverage of the issue.
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Old 10-30-2007, 09:40 AM   #6
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I treat my COLA'd gov't pension as if it were the stream of income from a ladder of treasury bonds. I calculate the initial principal amount such that by withdrawing an amount each year equal to my pension + inflation (both interest and liquidated principal) the final balance will be zero at the end of my 30 year remaining life expectancy. I then use that principal amount to recalculate my asset allocation. With it I am pretty close to 40% equities, 60% fixed income. Without it I am at 80% equities. This calculation makes me comfortable with the high allocation to equities. My pension covers all of my non-discretionary expenses so I can sleep well while taking more risks with my investments.

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Old 10-30-2007, 03:56 PM   #7
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Many Thanks for the responses. And the M* links were great.
I don't think I'll go 100% equities but will still lean towards the aggressive side (80-90% stock) for awhile...just gotta tackle my percentages among classes next.

again - thanks for the useful info,
1-0
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Old 10-30-2007, 07:57 PM   #8
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Originally Posted by One-Zero View Post
I don't think I'll go 100% equities but will still lean towards the aggressive side (80-90% stock) for awhile...just gotta tackle my percentages among classes next.
We not only treat my military pension as its bond equivalent but also our projected Social Security income. Spouse will start drawing her military pension in another 15 years.

We're 7.5% cash (just couldn't resist those PenFed CDs) and the rest of the ER portfolio is in stocks or stock ETFs. The cash % is about as high as we need it to go. And considering future pensions, we should probably go on margin...
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Old 10-30-2007, 08:11 PM   #9
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I was going to use the "pension = bond" idea for AA, but what about the research showing that some bonds actually improve the stability of your portfolio without decreasing returns? I can't remember whose book that was, but one of the poster's from MB's link summarized:

"to my surprise, at withdrawal time the asset allocation that appears to produce the greatest amount of monthly income over 30 years of retirement is 40% stock and 60% bonds (at the 90% success rate), or 25% stock and 75% bonds (99% success rate). Increasing the stock allocation actually reduces the chances for success."

So even if you're getting a pension, why wouldn't you want to own some bonds?
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Old 10-30-2007, 08:17 PM   #10
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So even if you're getting a pension, why wouldn't you want to own some bonds?
Let's see, stocks have reliably turned in the highest long-term returns (especially small-cap stocks) while bonds have barely managed to beat inflation. It seems to defy mathematical possibility that bonds could raise the returns of stocks, doesn't it?

They don't. They reduce the portfolio's overall volatility. When you're selling a portion of your portfolio over extended periods of time (for rebalancing or for income), bonds help ensure that the portfolio won't be down as much as it could be if you were carrying out the same strategy with stocks.

If you want to reduce volatility in order to sleep at night, then own bonds.

If you want to reduce volatility in order to never risk having to sell equities when they're down (as most of these studies simulate), then own bonds. Note that most of these studies also stipulate a constant withdrawal rate, yet 99% of us ERs could reduce our withdrawals during a prolonged downturn.

If you can avoid having to sell stocks in all but the worst market downturns, and even in that situation you think you'd be selling winners and reinvesting dividends on the losers, then you don't need bonds.
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Old 10-31-2007, 12:46 AM   #11
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So even if you're getting a pension, why wouldn't you want to own some bonds?
.. when the pension (COLA) covers more than what you will ever need.
the pension fund will never suspend or reduce payment.
you do not care about volatility.
you can always sleep well no matter what the market or the economy is doing.
you realize money is not everything in life.
you have no desire to leave tons of money behind.
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Old 10-31-2007, 08:52 AM   #12
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We use the NPV of our pensions when you do asset-allocation and count them as fixed income. But we actually deduct the pensions from the budget and then calculate the SWR of the remaining real portfolio to assess our financial strength.
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Would this make sense?
Old 11-13-2007, 12:50 PM   #13
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Would this make sense?

Thanks for the info...
I'm still trying to break things down. I recently acquired ESRbob's latest WLLM & workbook and have mulled over the Rational Investing Portfolio (RIP) idea quite a bit...
If I were to implement the RIP as portrayed (either the "sandwich"8-fund or his fully diversified version) but left bonds out of the mix and treat the COLA military as that portion - would it make sense? Technically I'd be close to 100% equities but for reasons listed throughout the thread it seems I'm covered on the bond allocation portion.
This would allow me to be a bit more aggressive with my current/future savings but reap benefits of spreading among classes as he suggests in the book.

Am I being overly-simplistic with my rationale here and missing some major downside??

many thanks....1-0
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