How does a guaranteed income stream affect stock/bond ratio?

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
GrowthSeeker
Posts: 204
Joined: Tue May 15, 2018 10:14 pm

How does a guaranteed income stream affect stock/bond ratio?

Post by GrowthSeeker » Sun Jun 24, 2018 8:22 pm

Some people, like my friend, have a significant defined benefit pension and/or annuity income stream in addition to Social Security. I myself, just have Social Security. And then everyone will have some amount of RMD income stream after age 71.

For example, assume that my friend, who is 70, has a SS income of $30K, plus a defined benefit stream and annuity stream of an additional $30K. I'll assume his expenses are $50K.
What is the effect of such streams of guaranteed income on the ideal stock/bond ratio?

I'm thinking that instead of stocks/bonds of 30/70 he could go with a much higher percentage of stocks.
Just because you're paranoid doesn't mean they're NOT out to get you.

jjface
Posts: 2571
Joined: Thu Mar 19, 2015 6:18 pm

Re: How does a guaranteed income stream affect stock/bond ratio?

Post by jjface » Sun Jun 24, 2018 8:27 pm

When you have guaranteed income of $60k and expenses of 50k you can do whatever you like with your asset allocation! 100% stocks for example.

User avatar
celia
Posts: 8600
Joined: Sun Mar 09, 2008 6:32 am
Location: SoCal

Re: How does a guaranteed income stream affect stock/bond ratio?

Post by celia » Sun Jun 24, 2018 8:51 pm

The standard rule is that your income stream(s) reduce how much you have to take out of your accounts for living expenses in retirement. In your friend's case, he/she doesn't have to take anything out. In fact, he/she may end up putting some of the income INTO his savings. He will still have to decide that stock/bond ratio he wants/needs. The answer may different if he has $10K vs $10M in savings. It would probably be good if he thought ahead to those future expenses that may happen: need for long-term care, new roof, new car, ...

UpperNwGuy
Posts: 1239
Joined: Sun Oct 08, 2017 7:16 pm

Re: How does a guaranteed income stream affect stock/bond ratio?

Post by UpperNwGuy » Sun Jun 24, 2018 8:54 pm

I am retired and in that situation. I have a 60/40 stock/bond ratio. My plan is to drop to 50/50 at age 75 and to 40/60 at age 80. I am thinking of long-term care expenses that will likely exceed my current income stream.

User avatar
willthrill81
Posts: 6449
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

Re: How does a guaranteed income stream affect stock/bond ratio?

Post by willthrill81 » Sun Jun 24, 2018 9:52 pm

If we defer SS benefits until age 70, they would easily cover our current necessary expenses. Our portfolio is for
(1) supporting retirement from age ~50 to 70,
(2) increasing our standard of living in retirement (i.e. 'fun money'),
(3) providing a safety net in the event of disadvantageous changes to SS, and
(4) leaving a legacy to our daughter and charities important to us.

Consequently, we have the ability to take on about as much risk as we can emotionally tolerate. If we wanted to be 100% stocks all the time, we could.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

GrowthSeeker
Posts: 204
Joined: Tue May 15, 2018 10:14 pm

Re: How does a guaranteed income stream affect stock/bond ratio?

Post by GrowthSeeker » Sun Jun 24, 2018 10:54 pm

I guess what I was thinking was something like this:
If one had to have $xxx in bonds to produce a $30K guaranteed income stream per year, and if those theoretical bonds were paying 3%, then this income stream is equivalent to $1 M of net worth invested in bonds.
So if the person actually has $1M of money to be invested, you could think of it as though they have this other $1 M in bonds, so to make a 50:50 portfolio, they can put all $1 M in stocks.

What I'm asking is: is there a BH way of looking at asset allocation that has guaranteed income stream as part of the equation?
Just because you're paranoid doesn't mean they're NOT out to get you.

ReadyOrNot
Posts: 194
Joined: Sun Aug 21, 2016 1:51 pm

Re: How does a guaranteed income stream affect stock/bond ratio?

Post by ReadyOrNot » Sun Jun 24, 2018 11:55 pm

The previously posted view that if the guaranteed income is greater than the needed income, you can invest in any way you want is probably the closest to a Boglehead view. The optimum is probably as much in stocks as what lets you sleep well and stay the course through any future downturn, to maximize worry-fee returns.
This allows a higher percentage in stocks than your example.

Doctor Rhythm
Posts: 166
Joined: Mon Jan 22, 2018 3:55 am

Re: How does a guaranteed income stream affect stock/bond ratio?

Post by Doctor Rhythm » Mon Jun 25, 2018 1:43 am

Treating guaranteed income (e.g., pension) as a bond equivalent seems tricky given that there isn't any principal that you can draw upon. Having $1M in bonds that pays out $30K a year in income is a lot more valuable than having $30K in income in the form of a pension.

ThrustVectoring
Posts: 583
Joined: Wed Jul 12, 2017 2:51 pm

Re: How does a guaranteed income stream affect stock/bond ratio?

Post by ThrustVectoring » Mon Jun 25, 2018 1:57 pm

Doctor Rhythm wrote:
Mon Jun 25, 2018 1:43 am
Treating guaranteed income (e.g., pension) as a bond equivalent seems tricky given that there isn't any principal that you can draw upon. Having $1M in bonds that pays out $30K a year in income is a lot more valuable than having $30K in income in the form of a pension.
There's tricks you can pull with leverage to get equivalent results. Like, if you have $2M in stocks and $30k/yr in annual income and you want to transform it into 100% stocks for some reason, you could use SPY futures (or call options, or straight margin loans) to pay $30k/yr in leverage costs and get approximately $3M worth of exposure to stock market price changes. It's harder to do this if you have less assets - probably the way to go is to buy $2500 or so of S&P 500 call options every month.
Current portfolio: 60% VTI / 40% VXUS

retiredjg
Posts: 34382
Joined: Thu Jan 10, 2008 12:56 pm

Re: How does a guaranteed income stream affect stock/bond ratio?

Post by retiredjg » Mon Jun 25, 2018 4:15 pm

GrowthSeeker wrote:
Sun Jun 24, 2018 8:22 pm
I'm thinking that instead of stocks/bonds of 30/70 he could go with a much higher percentage of stocks.
He probably can if he wants to. This is called an "ability" to take risk. "Wants to" has to do with "willingness" to take risk and it is much more important than ability in a case like this.

A person can have a high ability to take risk and not be willing. A person like that should not do it because s/he will be miserable. And for no good reason. There is nothing meaningful to be gained.


Some people actually do consider their income stream to be bond like. I don't know how they do the math. Others don't bother and just see it as a reduction of what needs to come from a portfolio which they set according to their own designs. I'm in that camp.

delamer
Posts: 6396
Joined: Tue Feb 08, 2011 6:13 pm

Re: How does a guaranteed income stream affect stock/bond ratio?

Post by delamer » Mon Jun 25, 2018 4:25 pm

This issue has come up before.

Some feel the way you do — if your friend is not dependent on savings to pay retirement expenses, then why not take more risk with a high equity allocation?

Others feel that if your friend does not need to take risk to grow his portfolio in order to pay his expenses, then why not be more conservative?

We are in that situation and chosen to go with the first option. This is in part because we think of the money as being invested for our kids, who have a very long time horizon.

User avatar
willthrill81
Posts: 6449
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

Re: How does a guaranteed income stream affect stock/bond ratio?

Post by willthrill81 » Mon Jun 25, 2018 7:09 pm

Doctor Rhythm wrote:
Mon Jun 25, 2018 1:43 am
Treating guaranteed income (e.g., pension) as a bond equivalent seems tricky given that there isn't any principal that you can draw upon. Having $1M in bonds that pays out $30K a year in income is a lot more valuable than having $30K in income in the form of a pension.
That might not be true, especially if the pension is inflation-adjusted and offered by a solid backer. While the ability to draw down principal if needed is a big advantage for the bonds, but inflation can (and has) ravage nominal bonds. The recipient of an inflation-adjusted pension need not be concerned with inflation.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

User avatar
willthrill81
Posts: 6449
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

Re: How does a guaranteed income stream affect stock/bond ratio?

Post by willthrill81 » Mon Jun 25, 2018 7:14 pm

GrowthSeeker wrote:
Sun Jun 24, 2018 10:54 pm
I guess what I was thinking was something like this:
If one had to have $xxx in bonds to produce a $30K guaranteed income stream per year, and if those theoretical bonds were paying 3%, then this income stream is equivalent to $1 M of net worth invested in bonds.
So if the person actually has $1M of money to be invested, you could think of it as though they have this other $1 M in bonds, so to make a 50:50 portfolio, they can put all $1 M in stocks.

What I'm asking is: is there a BH way of looking at asset allocation that has guaranteed income stream as part of the equation?
There isn't a specific way to incorporate an income stream into one's AA. Obviously, if the income is inflation-adjusted, it's more valuable than otherwise. It also depends on how long you anticipate being able to draw on the income stream; longer time horizons make the income more valuable. If you were using the '4% rule', which was designed with 30 year retirements in mind, a $30k inflation-adjusted annual income would be worth about $750k in today's dollars.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

CurlyDave
Posts: 755
Joined: Thu Jul 28, 2016 11:37 am

Re: How does a guaranteed income stream affect stock/bond ratio?

Post by CurlyDave » Mon Jun 25, 2018 11:45 pm

Actually, there is this fairly famous guy named Bogle (remember him?) who recommends treating an income stream as a bond-like investment when determining AA.

At one point the recommendation was to multiply the annual income by about 20 and think of that as roughly equivalent to a bond investment.

With current interest rates I would multiply by something closer to 25, and that would still be conservative.

For DW and I, who both have pensions and SS, even multiplying by 20 produces a situation where we just don't have enough of a portfolio to achieve even a 50/50 AA. As a practical matter, I tilt heavily to stocks, even though we are both retired. I just moved about a year's worth of spending into a money market and out of equities, but our investible assets are mostly in stocks.

I know there is great controversy over this concept, but it certainly seems reasonable to me.

NoHeat
Posts: 224
Joined: Sun Sep 18, 2016 10:13 am

Re: How does a guaranteed income stream affect stock/bond ratio?

Post by NoHeat » Tue Jun 26, 2018 1:14 am

GrowthSeeker wrote:
Sun Jun 24, 2018 10:54 pm
I guess what I was thinking was something like this:
If one had to have $xxx in bonds to produce a $30K guaranteed income stream per year, and if those theoretical bonds were paying 3%, then this income stream is equivalent to $1 M of net worth invested in bonds.
So if the person actually has $1M of money to be invested, you could think of it as though they have this other $1 M in bonds, so to make a 50:50 portfolio, they can put all $1 M in stocks.
An inability to sell bonds in order to rebalance during a stock-market downturn is a problem with the idea that bonds can be fully replaced by an annuity that pays the same interest. Bonds are liquid, annuities are not.

Of course, if the annuity is so large that it provides your entire income, then sure, you can do as you please with the remaining assets, including putting them all into stocks.

If the annuity is not so large, as is more likely, then you'd still want to have some bonds, for rebalancing. Another way of looking at it is the bucket approach, where the first bucket for ten years of living is bonds and the second bucket is stocks. If you then add an annuity to that scheme, you won't need a full ten years of expenses to be paid by the bonds, and the overall ratio of bonds/stocks can go down, but not to zero.

User avatar
nisiprius
Advisory Board
Posts: 37051
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: How does a guaranteed income stream affect stock/bond ratio?

Post by nisiprius » Tue Jun 26, 2018 6:20 am

(Despite Bogle) I don't think it makes sense to try to represent a guaranteed income stream as a "frozen" bond allocation equal to the present value of the stream, particularly when the stream is a lifetime stream (and therefore mixes in one number that has a longevity dependence with several others that don't.

The obvious thing is to subtract the guaranteed income stream from expenses, and then judge the ability of the portfolio to make up the difference.

Thus, for example--I'm going to change the numbers so the difference isn't negative and make the mental arithmetic easier--if you need $40,000 a year, and you have a $1,000,000 portfolio, you have twenty-five times needed income and are hoping to withdraw 4% of $1,000,000 in the first year (and the same amount, inflation-adjusted, thereafter), a 4% "safe withdrawal rate.

If you now add to the picture in a guaranteed income of $20,000 a year, you now need only $40,000 - $20,000 = $20,000/year from the portfolio and thus need only a 2% "safe withdrawal rate."

The portfolio might change, not because you have added a phantom "frozen bond" allocation to it, but because you have changed the required withdrawal rate.

The part that everyone seems to get wrong is that there are no objective answers here. In your illustration, the portfolio does not need to provide any income at all; in mine, it is a 2% rate which is generally considered safe for any reasonable allocation. So, any allocation will work.

The investor can raise stock allocation if he likes but there is no objective reason to do so. It is purely a matter of increasing versus decreasing relative risk aversion. The person with increasing relative risk aversion says "I do not need to take any risk at all, so I'll just put it all in the bank." The person with decreasing relative risk aversion says "I can afford to lose it all, so I can take any risks I want to."
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

User avatar
bertilak
Posts: 6158
Joined: Tue Aug 02, 2011 5:23 pm
Location: East of the Pecos, West of the Mississippi

Re: How does a guaranteed income stream affect stock/bond ratio?

Post by bertilak » Tue Jun 26, 2018 7:00 am

GrowthSeeker wrote:
Sun Jun 24, 2018 8:22 pm
And then everyone will have some amount of RMD income stream after age 71.
An RMD is not an income stream.
  • You are not required to spend the RMD. The amount distributed can be distributed to a taxable investment account. The overall portfolio size can be left the same. If we take taxes into consideration then any IRA distribution (including an RMD) effectively cuts down your income stream and does not ad to it.
  • Once you reach the age 59.5 you can take as much as you want from an IRA. An RMD does not give you any additional options. Instead it puts a restriction on your choices: a minimum amount you must distribute, and owe taxes on.
Last edited by bertilak on Tue Jun 26, 2018 7:03 am, edited 1 time in total.
May neither drought nor rain nor blizzard disturb the joy juice in your gizzard. -- Squire Omar Barker, the Cowboy Poet

UpperNwGuy
Posts: 1239
Joined: Sun Oct 08, 2017 7:16 pm

Re: How does a guaranteed income stream affect stock/bond ratio?

Post by UpperNwGuy » Tue Jun 26, 2018 7:03 am

nisiprius wrote:
Tue Jun 26, 2018 6:20 am
(Despite Bogle) I don't think it makes sense to try to represent a guaranteed income stream as a "frozen" bond allocation equal to the present value of the stream, particularly when the stream is a lifetime stream (and therefore mixes in one number that has a longevity dependence with several others that don't.

The obvious thing is to subtract the guaranteed income stream from expenses, and then judge the ability of the portfolio to make up the difference.

*** deleted material ***

The investor can raise stock allocation if he likes but there is no objective reason to do so. It is purely a matter of increasing versus decreasing relative risk aversion. The person with increasing relative risk aversion says "I do not need to take any risk at all, so I'll just put it all in the bank." The person with decreasing relative risk aversion says "I can afford to lose it all, so I can take any risks I want to."
I totally agree with this. It is simplicity at its finest.

indexonlyplease
Posts: 1295
Joined: Thu Apr 30, 2015 12:30 pm
Location: Florida

Re: How does a guaranteed income stream affect stock/bond ratio?

Post by indexonlyplease » Tue Jun 26, 2018 7:27 am

retiredjg wrote:
Mon Jun 25, 2018 4:15 pm
GrowthSeeker wrote:
Sun Jun 24, 2018 8:22 pm
I'm thinking that instead of stocks/bonds of 30/70 he could go with a much higher percentage of stocks.
He probably can if he wants to. This is called an "ability" to take risk. "Wants to" has to do with "willingness" to take risk and it is much more important than ability in a case like this.

A person can have a high ability to take risk and not be willing. A person like that should not do it because s/he will be miserable. And for no good reason. There is nothing meaningful to be gained.


Some people actually do consider their income stream to be bond like. I don't know how they do the math. Others don't bother and just see it as a reduction of what needs to come from a portfolio which they set according to their own designs. I'm in that camp.
I am in that situation where my pension covers our expenses. We both are many years from SS. So I have thought of this many times. I could go with a higher risk AA. I now am at 50/50 AA. 3 years ago before retirement I was 100 stock funds. My thinking is why take the extra risk I don't need. Also, I have never had this much money in a stock market decline. So I have now idea how I would act. But the 50/50 AA makes me think this is good enough and I won't do anything stupid in a declining market.

I learned all that informantion on this blog.

The Wizard
Posts: 12437
Joined: Tue Mar 23, 2010 1:45 pm
Location: Reading, MA

Re: How does a guaranteed income stream affect stock/bond ratio?

Post by The Wizard » Tue Jun 26, 2018 7:30 am

nisiprius wrote:
Tue Jun 26, 2018 6:20 am
(Despite Bogle) I don't think it makes sense to try to represent a guaranteed income stream as a "frozen" bond allocation equal to the present value of the stream, particularly when the stream is a lifetime stream (and therefore mixes in one number that has a longevity dependence with several others that don't...
Correct.
As several others mentioned, the focus needs to be on income in retirement, not simply assets.

And the OP mentions RMDs in the same breath as pensions, annuities and SS.
Wrong.
RMDs are simply portfolio withdrawals with a government mandated SWR.
In my case, for example, my portfolio withdrawals will DECREASE once I start RMDs in 2020 along with age 70 SS. My portfolio withdrawals have been larger in my pre-70 years as I bridge the gap to SS...
Attempted new signature...

indexonlyplease
Posts: 1295
Joined: Thu Apr 30, 2015 12:30 pm
Location: Florida

Re: How does a guaranteed income stream affect stock/bond ratio?

Post by indexonlyplease » Tue Jun 26, 2018 7:41 am

CurlyDave wrote:
Mon Jun 25, 2018 11:45 pm
Actually, there is this fairly famous guy named Bogle (remember him?) who recommends treating an income stream as a bond-like investment when determining AA.

At one point the recommendation was to multiply the annual income by about 20 and think of that as roughly equivalent to a bond investment.

With current interest rates I would multiply by something closer to 25, and that would still be conservative.

For DW and I, who both have pensions and SS, even multiplying by 20 produces a situation where we just don't have enough of a portfolio to achieve even a 50/50 AA. As a practical matter, I tilt heavily to stocks, even though we are both retired. I just moved about a year's worth of spending into a money market and out of equities, but our investible assets are mostly in stocks.

I know there is great controversy over this concept, but it certainly seems reasonable to me.
I like the idea but my thinking my pension covers expenses. One day SS will give us more. My 50/50 AA just sits there for large purchased of vacations, purchase cars ext. I like keeping all separate so far. This make me think no matter what the market does I have plenty in bonds (my stable value fund) that I can get money for any large purchase or extra income.

SGM
Posts: 2763
Joined: Wed Mar 23, 2011 4:46 am

Re: How does a guaranteed income stream affect stock/bond ratio?

Post by SGM » Tue Jun 26, 2018 9:24 am

Many are in the situation where various income streams cover more than their needs and do not accumulate a large portfolio solely for the idea of spending it all in retirement. Some have other goals and perceived benefits of having a large portfolio and will never have an AA of age in bonds. If one looks at future income as bond-like then one is able to risk a higher stock allocation assuming no behavioral errors.

Post Reply