How to treat Pension in AA?
How to treat Pension in AA?
How do you treat pension in your AA? Is it like bond?
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Re: How to treat Pension in AA?
Speaking strictly for myself, I treat it solely as income and not part of my AA.
Re: How to treat Pension in AA?
there have been a couple of threads on this in the last year or two.
the bottom line is most investors do not include their pension in their a.a. however, there is a formula to do so, in which the pension is "annuitized" as a bond -- how much cash would generate that much income. i found it interesting to perform the calculations, but i do not personally include these numbers in calculating my a.a. obviously, it will call for a larger percentage of equities in a portfolio, problematic for a retiree, or any investor, as it does skew the numbers. a related question would be: " do those investors who have a s.p.i.a. in their portfolio count that as a bond?" neither a spia or a pension in reality represent monies available for investment, but simply income streams.
i am just grateful to have a pension, and leave the advanced number-crunching to others.
the bottom line is most investors do not include their pension in their a.a. however, there is a formula to do so, in which the pension is "annuitized" as a bond -- how much cash would generate that much income. i found it interesting to perform the calculations, but i do not personally include these numbers in calculating my a.a. obviously, it will call for a larger percentage of equities in a portfolio, problematic for a retiree, or any investor, as it does skew the numbers. a related question would be: " do those investors who have a s.p.i.a. in their portfolio count that as a bond?" neither a spia or a pension in reality represent monies available for investment, but simply income streams.
i am just grateful to have a pension, and leave the advanced number-crunching to others.
Re: How to treat Pension in AA?
.
marek,
You asked two separate questions that must be addressed seperately.
marek,
You asked two separate questions that must be addressed seperately.
As an income stream to help pay bills.marek wrote:How do you treat pension in your AA?
- It reduces income needs from investable assets (portfolio) used to pay bills.
- A pension, thus, affects ability and need to take risk with those investable assets. This contradicts potential implications by the second question.
Can a pension (as a Bond) be used to rebalance and buy more Equities when they get crushed?... no, is not a Bond.marek wrote:Is it like bond?
Landy |
Be yourself, everyone else is already taken -- Oscar Wilde
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Re: How to treat Pension in AA?
I don't. Pension, Social Security, home equity/mortgage are kept outside of the asset allocation. Only true investable assets are considered. The pension is used for planning purposes in the long term as a future income stream and will help determine the retirement point.marek wrote:How do you treat pension in your AA? Is it like bond?
Brian
Re: How to treat Pension in AA?
I used to try to equate it to a bond in my (overly complex) asset allocation but dropped that idea and now just deduct the monthly pension distribution from my bottom line (i.e. If I need $5000 to live on and have an income stream of $3000, I know that I only have to have enough additional income to make up the difference ($2000).
Keepin' it simple for the last 68 years.
Keepin' it simple for the last 68 years.
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Re: How to treat Pension in AA?
I count it as an income stream. Then I can determine how much I need in retirement assets to make up the difference between the pension and the desired income. I do invest a bit more aggressively, with a higher weighted stock allocation, because I know I will have the pension. This might get me to my desired retirement income at a slightly earlier age.
Re: How to treat Pension in AA?
I personally would not treat it as a bond in my AA, but would reduce my allocation to fixed income since my need to take risk would be lowered, so the end effect is the same. Some people compute the present value of future cash flows and treat it like a bond in their AA, but as pointed out, it can't be used for rebalancing, other than directing the cash flow to assets that are below target.
Kevin
Kevin
If I make a calculation error, #Cruncher probably will let me know.
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Re: How to treat Pension in AA?
I count it the way John Bogle has suggested any number of times. Quoting him, "I recommended -- as a crude starting point -- that an investor's bond position should be equal to his or her age. An investor age 65, then, would consider the propriety of a 65/35 bond/stock allocation. Clearly, such a rule must be adjusted to reflect an investor's objectives, risk tolerance, and overall financial position. (For example, pension and Social Security payments would be considered bondlike investments.)" See the wiki. http://www.bogleheads.org/wiki/Asset_Allocation
Personally speaking, I count it this way because it is a way of risk leveling. I'm retiring with a pension & 401k nest egg this spring. I would like to just take whatever the RMD is and spend what we need to, give away what we don't need, & have some chance to still grow the nest egg for our heirs. So what's a reasonable AA in the nest egg? I'd like to have enough stocks to grow it if possible for heirs, but without too much risk.
The risk I worry about is some 1980's Japan style kind of semi-permanent stock market crash where stocks drop 50% and settle there for my lifetime. So this is a table of gross income reduction after a 50% equities crash as a function of AA and fraction of income you were getting from the pension/SS before the crash. It just states the obvious that if you were at all stocks and you had no pension/SS you lose half your income, all bonds you lose nothing, AA was 50/50 and half your income was from pension/SS means you lose 25% of your income...... and so on.
The green line drawn on the table is one constant risk locus. All nest egg income at 30/70 AA with no pension gives a 15% income drop, all stocks with a 70% pension at 70/30 nest egg AA gives the same. That is about the level of belt tightening DW and I estimate we could easily stand at our age (69). We could stand more if we had to. Anyway, if I follow the green 15% loss locus line to the right to the 50% of income from pension/SS column it says I could have a 60/40 AA and risk the same 15% income loss. That is roughly where we are..... half of projected retirement income from pension/SS and AA close to 60/40. It feels pretty darn safe.
Bogle's age in bonds with pension/SS counted as a bond approach gives the same sort of AA increases with the size of pension/SS as this table does. It levels risk more or less automatically. Why not use it?
Disclosure: I posted this table at the end of an old thread, it got ignored and the thread died. Please somebody comment.
JW
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Personally speaking, I count it this way because it is a way of risk leveling. I'm retiring with a pension & 401k nest egg this spring. I would like to just take whatever the RMD is and spend what we need to, give away what we don't need, & have some chance to still grow the nest egg for our heirs. So what's a reasonable AA in the nest egg? I'd like to have enough stocks to grow it if possible for heirs, but without too much risk.
The risk I worry about is some 1980's Japan style kind of semi-permanent stock market crash where stocks drop 50% and settle there for my lifetime. So this is a table of gross income reduction after a 50% equities crash as a function of AA and fraction of income you were getting from the pension/SS before the crash. It just states the obvious that if you were at all stocks and you had no pension/SS you lose half your income, all bonds you lose nothing, AA was 50/50 and half your income was from pension/SS means you lose 25% of your income...... and so on.
The green line drawn on the table is one constant risk locus. All nest egg income at 30/70 AA with no pension gives a 15% income drop, all stocks with a 70% pension at 70/30 nest egg AA gives the same. That is about the level of belt tightening DW and I estimate we could easily stand at our age (69). We could stand more if we had to. Anyway, if I follow the green 15% loss locus line to the right to the 50% of income from pension/SS column it says I could have a 60/40 AA and risk the same 15% income loss. That is roughly where we are..... half of projected retirement income from pension/SS and AA close to 60/40. It feels pretty darn safe.
Bogle's age in bonds with pension/SS counted as a bond approach gives the same sort of AA increases with the size of pension/SS as this table does. It levels risk more or less automatically. Why not use it?
Disclosure: I posted this table at the end of an old thread, it got ignored and the thread died. Please somebody comment.
JW
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Retired at Last
Re: How to treat Pension in AA?
I think it is an interesting way to look at the problem. It doesn't cover everything (does not account for non-RMD funds like taxable/Roth, or if one wants to leave an inheritance (as you mention). But it does have a good value in helping one look at the question differently.JW Nearly Retired wrote: Please somebody comment.
Re: How to treat Pension in AA?
The chart is a good graphical representation of where you think you can put your AA based on the maximum annual income loss you are willing to accept and how much of your income comes from pension/SocSec. I like it.
Re: How to treat Pension in AA?
Regarding JW nearly retired's chart, the RMDs will later go up in later years after the initial loss with advancing age assuming the value of the IRAs remain fairly constant. I think the table would be applicable to withdrawals say at 4% inflation adjusted if you also adjust downward for a significant loss or if you use the RMD method to calculate safe withdrawal rates as suggested by Wade Pfau. Some adjustment would have to be made, I believe for using the percent withdrawal method. Maybe you could play around with different asumptions there. Certainly if one used the RMD method for withdrawals from non IRA accounts it is helpful as is. The graph also showcases the value of a pension, annuity and SS. Well done JW.
"Let us endeavor, so to live, that when we die, even the undertaker will be sorry." Mark Twain
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Re: How to treat Pension in AA?
This is the closest to how I consider it, but I would add the following:Kevin M wrote:I personally would not treat it as a bond in my AA, but would reduce my allocation to fixed income since my need to take risk would be lowered, so the end effect is the same. Some people compute the present value of future cash flows and treat it like a bond in their AA, but as pointed out, it can't be used for rebalancing, other than directing the cash flow to assets that are below target.
Kevin
Considering it in your AA is of little value unless you are retired and are receiving the pension, however the closer you get to retirement and the more sure you are that you are going to collect the pension the more it should be considered.
Calculating the present value of your pension is a good exercise, otherwise you will not understand how big the "bond-like" fixed income component is as compared to the rest of your investments. It is foolish (IMHO) to ignore this component, unless you just have so much money that you really don't care if your AA is essentially 80% bonds when you are looking for a 50/50 split.
To say you cannot re-balance a pension stream only makes sense if your bond exposure is made up purely from your pension (like mine is - but I'm fine with that small detail). Otherwise if you know the present value of your pension, it would be easy to rebalance the rest of your bond allocation. A pension acts merely as a single non-callable bond with a fixed coupon paid on a monthly basis, with a very long duration -- In comparison a $800,000, 30 year treasury bond earning 3% would look in your portfolio much like a $2000 a month pension. So if you had a million dollar portfolio and you were looking for a 50/50 split putting another $500,000 in bonds would really be doing your AA a dis-service IMO.
To be worried about the market swings of an 80% - 100% equity portfolio in retirement, if your retirement income is 100% covered by a pension & SS, is just unwarranted worry IMO.
fd
I love simulated data. It turns the impossible into the possible!
Re: How to treat Pension in AA?
This is completely backwards.Kevin M wrote:I personally would not treat it as a bond in my AA, but would reduce my allocation to fixed income since my need to take risk would be lowered, so the end effect is the same.
With less income needed from investable assets, there is less need for risk, so logically:
- One could INCREASE (not "reduce") the allocation to fixed income and accept lower expected return/income from the overall portfolio.
- Consequently, there is less (not more) need for riskier Equities.
Landy |
Be yourself, everyone else is already taken -- Oscar Wilde
Re: How to treat Pension in AA?
But the rule age in bonds together with capitalizing the value of a pension, which Mr. Bogle recommends, clearly has the consequence of placing a pensioner is a risker stock and bond portfolio than one who is without a pension.YDNAL wrote:This is completely backwards.Kevin M wrote:I personally would not treat it as a bond in my AA, but would reduce my allocation to fixed income since my need to take risk would be lowered, so the end effect is the same.
With less income needed from investable assets, there is less need for risk, so logically:
- One could INCREASE (not "reduce") the allocation to fixed income and accept lower expected return/income from the overall portfolio.
- Consequently, there is less (not more) need for riskier Equities.
Re: How to treat Pension in AA?
Then, Mr. Bogle is not being "logical." *dbr wrote:But the rule age in bonds together with capitalizing the value of a pension, which Mr. Bogle recommends, clearly has the consequence of placing a pensioner is a risker stock and bond portfolio than one who is without a pension.YDNAL wrote:This is completely backwards.Kevin M wrote:I personally would not treat it as a bond in my AA, but would reduce my allocation to fixed income since my need to take risk would be lowered, so the end effect is the same.
With less income needed from investable assets, there is less need for risk, so logically:
- One could INCREASE (not "reduce") the allocation to fixed income and accept lower expected return/income from the overall portfolio.
- Consequently, there is less (not more) need for riskier Equities.
There is also another ingredient to the mix known as Marginal Utility of Wealth.
http://www.cbsnews.com/8301-505123_162- ... ve-enough/
* not necessarily a stretch considering the long-held view that S&P 500 companies provide all international exposure that we need - failing to recognize that diversifying in International Stocks in FTSE 100, CAC, DAX, NIKKEI, Hang Seng, Shanghai Exchanges with "domestic exposure" from doing business in the US.... we digress!
Landy |
Be yourself, everyone else is already taken -- Oscar Wilde
Re: How to treat Pension in AA?
Yes, and also an ingredient called underestimating risk, which is a bad idea when it is not necessary to take risk. That with marginal utility are the two reasons Larry Swedroe suggests that need to take risk, or absence of same, trumps ability to take risk.
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Re: How to treat Pension in AA?
This is certainly one way to look at it if you consider that you have more money than you or your heirs will EVER need.YDNAL wrote:This is completely backwards.Kevin M wrote:I personally would not treat it as a bond in my AA, but would reduce my allocation to fixed income since my need to take risk would be lowered, so the end effect is the same.
With less income needed from investable assets, there is less need for risk, so logically:
- One could INCREASE (not "reduce") the allocation to fixed income and accept lower expected return/income from the overall portfolio.
- Consequently, there is less (not more) need for riskier Equities.
Somehow I tend to beleive that in most cases you can not predict the future, and that most people who are living off a pension in the first place do not have more money than they would ever need, therefore it does not make sense to dial the risk down, at the exact time when they could afford to at least take the same risk they had been taking prior to receiving the pension. In other words if you were comfortable with a 70/30 split before considering the pension, why would you not be comfortable with it after considering the pension. In all fairness to your AA, your money is MUCH more secure once your pension starts paying out, than it was invested in a BOND or BOND fund (IMHO.)
fd
I love simulated data. It turns the impossible into the possible!
Re: How to treat Pension in AA?
Landy correctly pointed out that I reversed the logic. A lower need to take risk could be a reason to increase one's allocation to fixed income and decrease one's allocation to equities, which would be the opposite of what one with a pre-determined AA might do if considering the PV of a fixed income stream as a bond. The thing is that the lower need to take risk might be a reason to modify one's AA and reduce the allocation to equities. As Larry says, no need to keep playing the game once you've won.
Kevin
Kevin
If I make a calculation error, #Cruncher probably will let me know.
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Re: How to treat Pension in AA?
It should do that. The portfolio risk is greater but the overall risk of reduced retirement income is the same.dbr wrote:
But the rule age in bonds together with capitalizing the value of a pension, which Mr. Bogle recommends, clearly has the consequence of placing a pensioner is a risker stock and bond portfolio than one who is without a pension.
Bogles approach levels the risk. It makes the risk of the pension + portfolio the same as the risk of a bigger portfolio that generates the same income. That is perfectly logical. It makes no sense whatsoever for me, who will have half my income from a pension, to have the same AA as somebody who has their savings and nothing more. I'd rather keep this same level of risk and get the higher returns.
It's the overall risk that counts. Where do you stop thinking just about the isolated portfolio? If the pension is 110% of my income needs am I free to deviate from age in bonds?
JW
Retired at Last
Re: How to treat Pension in AA?
I think the answer, in practice, depends on the relative size of your pension as a lump sum to the size of your overall portfolio
If it's a small amount and/or you're early in your career then I think it's fine to treat as a bond
If it is larger and would have a significant weight in your portfolio then I probably wouldn't because, as others have said, you can't rebalance with it if stocks tumble and you need to buy more to get your allocation back up
If it's a small amount and/or you're early in your career then I think it's fine to treat as a bond
If it is larger and would have a significant weight in your portfolio then I probably wouldn't because, as others have said, you can't rebalance with it if stocks tumble and you need to buy more to get your allocation back up
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Re: How to treat Pension in AA?
So what? Don't rebalance, your allocation will come back up if & when the recovery happens. If recovery never happens then you are better off with the lower stock allocation anyway. Japan crash an obvious example.og15F1 wrote:I think the answer, in practice, depends on the relative size of your pension as a lump sum to the size of your overall portfolio
If it's a small amount and/or you're early in your career then I think it's fine to treat as a bond
If it is larger and would have a significant weight in your portfolio then I probably wouldn't because, as others have said, you can't rebalance with it if stocks tumble and you need to buy more to get your allocation back up
Except for a minor effect from new contributions, I did no rebalancing in 2008-2012 and it worked just fine. I might have done some if I was much younger.
JW
Retired at Last
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Re: How to treat Pension in AA?
I count it as an income stream. However, if the pension is not indexed to CPI, you should calculate the inflationary impact on the pension, which will reduce the purchasing power of your pension. Over time, the reduction in real income becomes significant.
Re: How to treat Pension in AA?
So what is the answer? If one has a pension that meets all of your financial needs and is inflation indexed, should one be invested all in equities or all in bonds?
Re: How to treat Pension in AA?
The answer is, you can invest however you like.Reubin wrote:"So what is the answer? If one has a pension that meets all of your financial needs and is inflation indexed, should one be invested all in equities or all in bonds?"
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Re: How to treat Pension in AA?
It is completely logical to have an increased stock allocation for the investor with the pension compared to an investor that does not. The idea is that the two portfolios each have the same risk reward profile. Without knowing anything about expenses, we cannot make a final adjustment for risk. Another way of thinking about it: assume one investor has 500k in stocks and 500k in bonds and needs 40k per year, this would be exactly the same as an investor that has 750k in stocks, 250k in bonds and 500k in a bond like pension and needs 60k per year.
I talk about this and other ideas in a recent post:
http://www.bogleheads.org/forum/viewtop ... st=1592777
I talk about this and other ideas in a recent post:
http://www.bogleheads.org/forum/viewtop ... st=1592777
Last edited by MrMatt2532 on Thu Jan 24, 2013 12:52 pm, edited 2 times in total.
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Re: How to treat Pension in AA?
You can invest as aggressively or conservatively as you wish. I know people who are 100% equities and also people whose AA reflects their age, i.e. age in bonds. It really is a matter of what you are comfortable with. I am in same position and chose an AA of age in bonds. I know I can be more aggressive but choose not to.Reubin wrote:So what is the answer? If one has a pension that meets all of your financial needs and is inflation indexed, should one be invested all in equities or all in bonds?
Re: How to treat Pension in AA?
What if I have an option to take the pension as lump sum? That would be a chunk of $ that needs to be invested somewhere.
Re: How to treat Pension in AA?
If you run any of the retirement planning tools, there would typically be a provision to add a lump sum increment to a portfolio. At that point the plan would be that it would be invested in the same asset allocation as everything else. What AA you choose before the money is available and after the money is available might be different. If you choose the annuity, the plan would add the income stream to the income side of the model. The AA you choose if you have elected the income stream might be different from the AA you choose if you elect the lump sum. Choice of AA is a question of preference and judgement after considering need, ability, and willingness to take risk.marek wrote:What if I have an option to take the pension as lump sum? That would be a chunk of $ that needs to be invested somewhere.