Defined Benefits Pension as fixed income?

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af895
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Defined Benefits Pension as fixed income?

Post by af895 » Fri Jun 01, 2012 8:43 am

Hey all.

When considering equity/fixed income allocation, should an inflation-index, government defined benefits pension be taken into consideration?

William Bernstein seems to suggest an investor might consider reducing their bond allocation in consideration of a DB pension. ("The Investor's Manifesto")

Thoughts?

Obviously, this assumes the guaranteeing government won't declare bankruptcy.
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Re: Defined Benefits Pension as fixed income?

Post by daytona084 » Fri Jun 01, 2012 8:48 am

Yes that is exactly what I do. I use Excel (and I am sure there are other ways) to determine the present value (PV) of the defined benefit pension and count that as a "fixed income" asset.

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Re: Defined Benefits Pension as fixed income?

Post by sscritic » Fri Jun 01, 2012 9:04 am

You can or not as you wish. The real question is to what purpose. If you are going to blindly follow some internet advice to keep your age in bonds whether you do or do not count it as fixed income, then you are going to end up with completely different asset allocations depending on which side of the fence you fall on. That should not be your goal. Your actual ownership of stocks and regular bonds should be the same whatever you do.

A doesn't count: $500k in stocks, $500k in bonds.

B counts $1 million: $500k in stocks, 1.5 million in bonds, of which $500k are real bonds and $1 million is pension.

A and B compute different percentages, but have the same asset allocation and the same risks. You want to control risks, not percentages.

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Re: Defined Benefits Pension as fixed income?

Post by yobria » Fri Jun 01, 2012 9:09 am

You shouldn't call it a bond (since you don't own a bond), but you can use the income to net down your retirement expenses, thus reducing your SWR, and allowing you to add equities (now more ability to take risk) or reduce them (less need to take risk). Search for 100s of prior answers to this question.

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Re: Defined Benefits Pension as fixed income?

Post by richard » Fri Jun 01, 2012 9:22 am

yobria wrote:You shouldn't call it a bond (since you don't own a bond), but you can use the income to net down your retirement expenses, thus reducing your SWR, and allowing you to add equities (now more ability to take risk) or reduce them (less need to take risk). Search for 100s of prior answers to this question.
Exactly.

A defined benefit pension is not a bond. Among other things, it can't be traded.

If your expenses are 100 and you receive a 30 pension, the rest of your portfolio should be designed to fund the other 70.

This is a very frequently asked question.

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Re: Defined Benefits Pension as fixed income?

Post by Muchtolearn » Fri Jun 01, 2012 9:26 am

That sounds logical. You are making the assumption that the benefits will not be cut. More and more are. The reason is that the funds cling to an expected 8% return or reluctantly cut them to 7.5% when everybody knows this isn't possible. So then the plans are getting seriously underfunded and there is no choice other than to cut the benefits as the plans are underfunded. I am following this closely because it is a bubble I spotted years ago and have been waiting to see if it bursts.
Last edited by Muchtolearn on Sat Jun 02, 2012 7:47 am, edited 2 times in total.

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Re: Defined Benefits Pension as fixed income?

Post by tibidabo » Fri Jun 01, 2012 10:05 am

Muchtolearn wrote:That sounds logical. You are making the assumption that the benefits will not be cut. More and more are. The reason is that the funds cling to an expected 8% return or reluctantly cut them to 7.5% when everybody knows this isn't possible. So then the plans are getting seriously underfunded and there is nbo choice other than to cut the benefits as the plans are underfunded. I am following this closely because it is a bubble I spotted years ago and have been waiting to see if it burst.
It is true that plans are becoming underfunded, but not because of the unrealistic 8% expected return on assets.

Pension funding is determined by discounting liabilities to the present and comparing to current assets, rather than projecting assets and comparing to future liabilities. Liabilities are discounting using stipulated rates, which are more in the range of 4-6%.

The future isn't rosy, but it isn't armageddon.

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Re: Defined Benefits Pension as fixed income?

Post by Dandy » Fri Jun 01, 2012 3:35 pm

Certainly people in the identical shape one with and without a pension the one with the pension could be more aggressive. I think it is better to treat the pension as income and then determine your risk/allocation.

If you have a pension of 30,000 a year what bond equivalent value do you give it? One way is to determine what value of 30 year Treasuries would generate 30k per year. So if 30 year Treasuries are yielding 3% your pension would equate to $1,000,000 in bonds. If your 401k had $1,000,000 and you wanted to have 50% equities and 50% bonds - all your 401k would be in equities. That might be too aggressive for most retirees.

The pension is fixed but interest rates are not. Do you adjust the bond equivalent value of your pension when the yield on 30 yr Treasuries changes?? Suppose in 5 years 30 yr Treasuries are issued at 6% does that mean your pension bond equivalent should be changed to $ 500,000? If it drops to 2% you many not have enough money to put into equities to meet your target allocation.

It is much better to count the pension as income and because your income is higher you can decide to take a higher level of risk in your investment portfolio rather than treat a fixed income stream as a bond.

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Re: Defined Benefits Pension as fixed income?

Post by celia » Fri Jun 01, 2012 6:15 pm

Have you checked to see if the pension has COLA?
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Re: Defined Benefits Pension as fixed income?

Post by alec » Fri Jun 01, 2012 6:50 pm

CJOttawa wrote:Hey all!

Treating the DB income as the bond (fixed income) component of their portfolio, the recipient could adjust the asset allocation of their self-managed funds toward equity.

Thoughts?
Why? Just because you have a gov't pension?
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Re: Defined Benefits Pension as fixed income?

Post by sscritic » Fri Jun 01, 2012 6:58 pm

Dandy wrote: If you have a pension of 30,000 a year what bond equivalent value do you give it? One way is to determine what value of 30 year Treasuries would generate 30k per year. So if 30 year Treasuries are yielding 3% your pension would equate to $1,000,000 in bonds. If your 401k had $1,000,000 and you wanted to have 50% equities and 50% bonds - all your 401k would be in equities. That might be too aggressive for most retirees.
Others would call it just plain stupid. Why would anyone want to be 50-50 under those circumstances? Because they read on the internet that they should be 50-50? Bad idea. That 50-50 recommendation is for someone who isn't valuing their pension as a bond. Someone who values their pension as a bond shouldn't use a recommendation designed for someone who doesn't value their pension as a bond. [Someone 20 shouldn't use recommendations designed for someone age 90 and vice-versa.] The recommendation you use should fit your circumstances. A person who values their pension as a bond should be 25-75, not 50-50.

A: $1.5 million "bonds" ($1 million pension; $0.5 million real bonds) and $0.5 million stocks. That's 75% bonds.
B: $0.5 million real bonds and $0.5 million stocks. That's 50% bonds.

A and B have the same portfolios, but one measures it as 75% bonds and the other measures it as 50% bonds. It's not the percentage you attach to your investments, it's the investments you make that matter.

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Re: Defined Benefits Pension as fixed income?

Post by dbr » Fri Jun 01, 2012 8:12 pm

sscritic wrote: Others would call it just plain stupid. Why would anyone want to be 50-50 under those circumstances? Because they read on the internet that they should be 50-50? Bad idea. That 50-50 recommendation is for someone who isn't valuing their pension as a bond. Someone who values their pension as a bond shouldn't use a recommendation designed for someone who doesn't value their pension as a bond. [Someone 20 shouldn't use recommendations designed for someone age 90 and vice-versa.] The recommendation you use should fit your circumstances. A person who values their pension as a bond should be 25-75, not 50-50.

A: $1.5 million "bonds" ($1 million pension; $0.5 million real bonds) and $0.5 million stocks. That's 75% bonds.
B: $0.5 million real bonds and $0.5 million stocks. That's 50% bonds.

A and B have the same portfolios, but one measures it as 75% bonds and the other measures it as 50% bonds. It's not the percentage you attach to your investments, it's the investments you make that matter.
This is exactly right. The essence of the problem in this discussion is that there was/is not a prior understanding of how one arrives at an asset allocation, including the concept that the answer changes when we change to virtual recordkeeping, calling income streams bonds, and stuff like that.

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Re: Defined Benefits Pension as fixed income?

Post by JW-Retired » Fri Jun 01, 2012 8:25 pm

I admit this AA stuff is my pet peeve on this Forum. I clearly recall that John Bogle and others have recommend investors should use an AA of age-in-bonds with the pension/SS counted as a bond. That kind of AA is at least an objective and precisely defined quantity. People with the same retirement savings and income facts will get the identical number. IMO, that's much more useful to the average investor than the squishy-soft official Boglehead "consider your need, ability, and willingness to take risk"..... and then what? I guess you just shout out 60/40, or whatever leaps into your mind at that moment. Folks with similar retirement facts can and do seem to choose wildly different AAs using this method. I don't see how this kind of advice can be much help to a new investor. Right in the wiki we say that "asset allocation is one of the most important decisions that investors can make" but then don't tell him how to make their AA choice in any useful way.

I really think Bogleheads need to explain in detail how the "consider the need, ability, and willingness to take risk" AA selection process works. What's the step by step mathematical process that is used? If not mathematical, then what's the non-mathematical process in enough detail that somebody could at least semi-objectively apply it? I've never seen anything like this here....... I doubt it exists but perhaps I missed it. Please point me to it. Otherwise, IMO, those who cannot explain the Boglehead AA finding method in some detail should not really criticize those that can explain their alternate process.

Obviously, if the John Bogle formula comes out with an AA number that you don't like for whatever personal reason, by all means use another number.
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Re: Defined Benefits Pension as fixed income?

Post by LadyGeek » Fri Jun 01, 2012 9:05 pm

This discussion is already summarized in the wiki: Fixed income

Should we add defined benefits somewhere?
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Re: Defined Benefits Pension as fixed income?

Post by dbr » Fri Jun 01, 2012 9:39 pm

JW Nearly Retired wrote:I admit this AA stuff is my pet peeve on this Forum. I clearly recall that John Bogle and others have recommend investors should use an AA of age-in-bonds with the pension/SS counted as a bond. That kind of AA is at least an objective and precisely defined quantity. People with the same retirement savings and income facts will get the identical number.

snip
Of course the fact that the same savings and income facts generate the identical number would indicate that the method is faulty, as individuals vary in many, many ways each from each. The mathematics of the age-in-bonds with pension method is also clearly flawed as it is not hard to generate examples that place the actual investments at more than 100% equities, of if not in that impossible range, at least at such high proportions that most people would reject the result as defying common sense. The advice that one should consider becoming more conservative with age and that the presence of income streams should have an effect on what chooses is worth considering, though life may in reality be a little more subtle than that.

I do agree there is great frustration here, often glossed over. I think the resolution is that in the end the subject is a matter of judgment and a matter of preference. If one accepts as a fundamental that asset allocations somehow are choices along a continuum of greater possible reward obtainable only with greater possible danger, then the fact that this is a judgment and a preference becomes self evident. The mathematics is just a question of trying to quantify the various aspects of what constitutes reward and what constitutes danger.

I think a reading in Larry Swedroe's books about need, ability, and willingness makes a bona-fide but not perhaps sufficient attempt at laying out that analysis.

Another aspect is that, while asset allocation is important, I think to say THE MOST important is hyperbole. If nothing else it takes fairly large changes in the choice of allocation to create large changes in consequence. There is no need for precision.

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Re: Defined Benefits Pension as fixed income?

Post by k-slice » Fri Jun 01, 2012 9:45 pm

Of course you are correct.
You have a lifetime annuity payment courtesy of uncle sam.

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Re: Defined Benefits Pension as fixed income?

Post by bobcat2 » Fri Jun 01, 2012 9:58 pm

Hi CJOttawa,

What you want to know is, how can I safely turn the equity and bond holdings I own today into retirement income? Not, how can I turn my retirement income into a stock of wealth as of today? In other words your retirement problem is how to turn your portfolio of equities and bonds into retirement income. There is little point in trying to do the reverse and turn a stream of retirement income into a current stock of wealth.

I have rarely met a financial economist who wouldn't view the problem the first way, and I have met many. OTOH many financial professionals do approach the problem by attempting to find the present value of both SS and pensions and then including these PVs as part of the retirement portfolio asset allocation. Why they view this approach as reasonable is not clear. :(

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Re: Defined Benefits Pension as fixed income?

Post by gwrvmd » Sat Jun 02, 2012 12:52 am

Yes, when defining retirement AA, pensions are fixed income/bonds
An indexed pension/Social Security is considered to be worth a bond equal to 14x the annual pension payment
A non indexed pension is considered to be worth a bond equal to 11x the annual pension payment
When you do this calculation, you find that many retirees should increase their equities to be 60/40 or 50/50 or whatever they think they are.
I think this is what John Bogle means when he said AA of age in bonds with pension/SS counted as a bond. He does not mean for a 75 year old with a pension and SS to have 75% of his investable assets in bonds.
I definately agree with OP CJottowa that " When when treating DB (pension) as a bond, the receipient could adjust the AA of their self-managed funds toward equity"........Gordon

Addendum
I am a retiree with 2 pensions (one indexed, the other not) and SS
All my self-managed assets are in equities
Using Jack Bogle's (and my) retirement AA calculation, my retirement AA is approx. 60:40
If I used the conventional calculation my retirement AA would be 100% equities which would scare me because that is much too risky :wink: Gordon
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Re: Defined Benefits Pension as fixed income?

Post by fidelio » Sat Jun 02, 2012 3:17 am

LadyGeek wrote:This discussion is already summarized in the wiki: Fixed income

Should we add defined benefits somewhere?
lady geek / taylor, mel / et al.:

perhaps. i'm not sure there is a consensus, but it's a huge issue for anyone attempting to set an a.a. who has either an employer's defined benefit payment or is collecting social security. probably most of the retired members of this forum possess or will possess at least one such monthly payment. i hope to be collecting both eventually, and counting these two factors as a bond investment would completely change, or skew, the amount of equities to be kept in my portfolio.

for example, let's say, simplified for the purpose of illustration or discussion, that a fellow has a portfolio of $750k, and he wishes to have a 70-30 bond-equity asset allocation. the "normal" calculation would be $525k in bonds and 225 in equities. but let's also say he is retired and also collects $1500 and 2000 per mo. pension and social security, respectively. according to the formulae discussed in this thread, if i have the nos. right (factors of 11 and 14, etc., equalling 198k and 336K, again respectively), this would tell us that we have a portfolio worth about $1.28 million. at 30% equities, we would have to place about $385k in equities in our hypothetical portfolio, leaving only 365k in bonds, quite a difference from the 525-225 bonds-stocks listed for the "conventional" asset allocation calcuation.

this isn 't the first i've heard of so valuing monthly pensions, but my view is that whether or not they should be annualized and calcuated as a FI addition to a portfolio should be made clear in some "official" way, or should at least be articulated in the forum wikis so that this issue can be addressed by investors when settling on their asset allocations. another knotty issue would be "re-balancing" of allocation upon commencement of such a monthly payment.

thanks, artie

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Re: Defined Benefits Pension as fixed income?

Post by JW-Retired » Sat Jun 02, 2012 7:10 am

dbr wrote: Of course the fact that the same savings and income facts generate the identical number would indicate that the method is faulty, as individuals vary in many, many ways each from each. The mathematics of the age-in-bonds with pension method is also clearly flawed as it is not hard to generate examples that place the actual investments at more than 100% equities, of if not in that impossible range, at least at such high proportions that most people would reject the result as defying common sense.
It can only tell you should have all equities if you have a tiny nest egg compared to your annutized income stream. In that case it really doesn't matter. I really think most people will get a perfectly reasonable common sense satisfying result with the age-in-bonds with pension method. I have a hefty pension component to consider and I find it does for me. At least it will give any investor a rational common starting point to adjust from. The alternative is really a non-method.

Long ago I polled Bogleheads with facts about nest egg sizes vice pension incomes asking what AA would you recommend for this investor with a sizable pension? The answers basically ranged all the way from all bonds to nearly all stocks. Some said you might as well be heavy in stocks for your heirs sake since you are well covered by the pension. Others said you have no need to take risk so go all bonds. Others were spread out in between. I'd say something that malleable is the faulty method.
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Re: Defined Benefits Pension as fixed income?

Post by carolinaman » Sat Jun 02, 2012 7:25 am

celia wrote:Have you checked to see if the pension has COLA?
Good question. I have a govt pension in NC. Our retirement system does not guarantee a COLA but has typically kept pace with inflation. However, pensions are dependent upon investment performance to maintain their required level of funding. If they sustain an extended period of investment underperformance, I could see them withholding any COLA for years. Until recent years, that did not seem to be a major risk, but clearly is now. IMO pensions, like SS, will deal with their underfunded situation by withholding or reducing COLAs from true inflation. Therefore, I think that pension recipients should consider inflation impact, at least to some extent, in their retirement planning.

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Re: Defined Benefits Pension as fixed income?

Post by Muchtolearn » Sat Jun 02, 2012 7:48 am

tibidabo wrote:
Muchtolearn wrote:That sounds logical. You are making the assumption that the benefits will not be cut. More and more are. The reason is that the funds cling to an expected 8% return or reluctantly cut them to 7.5% when everybody knows this isn't possible. So then the plans are getting seriously underfunded and there is nbo choice other than to cut the benefits as the plans are underfunded. I am following this closely because it is a bubble I spotted years ago and have been waiting to see if it burst.
It is true that plans are becoming underfunded, but not because of the unrealistic 8% expected return on assets.

Pension funding is determined by discounting liabilities to the present and comparing to current assets, rather than projecting assets and comparing to future liabilities. Liabilities are discounting using stipulated rates, which are more in the range of 4-6%.

The future isn't rosy, but it isn't armageddon.
Your explanation is superior to mine. Whatever it is, it will be settled somehow by the public, the unions and the allocators of funds. I am going to observe.

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Re: Defined Benefits Pension as fixed income?

Post by alec » Sat Jun 02, 2012 7:51 am

fidelio wrote:
LadyGeek wrote:This discussion is already summarized in the wiki: Fixed income

Should we add defined benefits somewhere?
lady geek / taylor, mel / et al.:

perhaps. i'm not sure there is a consensus, but it's a huge issue for anyone attempting to set an a.a. who has either an employer's defined benefit payment or is collecting social security. probably most of the retired members of this forum possess or will possess at least one such monthly payment. i hope to be collecting both eventually, and counting these two factors as a bond investment would completely change, or skew, the amount of equities to be kept in my portfolio.

for example, let's say, simplified for the purpose of illustration or discussion, that a fellow has a portfolio of $750k, and he wishes to have a 70-30 bond-equity asset allocation. the "normal" calculation would be $525k in bonds and 225 in equities. but let's also say he is retired and also collects $1500 and 2000 per mo. pension and social security, respectively. according to the formulae discussed in this thread, if i have the nos. right (factors of 11 and 14, etc., equalling 198k and 336K, again respectively), this would tell us that we have a portfolio worth about $1.28 million. at 30% equities, we would have to place about $385k in equities in our hypothetical portfolio, leaving only 365k in bonds, quite a difference from the 525-225 bonds-stocks listed for the "conventional" asset allocation calcuation.

this isn 't the first i've heard of so valuing monthly pensions, but my view is that whether or not they should be annualized and calcuated as a FI addition to a portfolio should be made clear in some "official" way, or should at least be articulated in the forum wikis so that this issue can be addressed by investors when settling on their asset allocations. another knotty issue would be "re-balancing" of allocation upon commencement of such a monthly payment.

thanks, artie
Artie,

This issue comes up every so often, and IMHO your thinking above is a little misguided. To quoth myself from a 2011 conversation:
D Paul wrote:My allocation goal is 50/50 equities/bonds
I don't really think that this is your goal. Most people come up with this stock/bond allocation without doing any real calculations and base this decision on their risk tolerance, age, etc. For example, "I'm 60 and have a 'medium' tolerance for risk." Is this type of "analysis" really how one wants to base their retirement income on? I don't think so.

A goal would be "I want $30,000 in retirement income". Since you have a pension of $16,800 per year, you need $13,200 per year from your portfolio. Thus, you set up your portfolio [in stocks and bonds] to generate the $13,200. You can do this multiple ways, like through monte carlo simulations with various stock/bond %'s, TIPS ladders, life annuities, etc.

For arguments sake, let's say that you decide on an AA of 50/50 stocks/bonds to generate this $13,200. And when you take your pension into account, your overall AA is 20% stocks and 80% bonds. As sscritic has said in the past [IIRC], you should be just as happy with 50/50 ignoring the pension and 20/80 not ignoring the pension.

The AA of your [non-pension] portfolio is the end result of a whole bunch of calculations, not the starting point like "I think I should be 50/50 given my age and risk tolerance, so I should put 80% of my investment portfolio into stocks to take into account of my pension." IMHO, the latter is quite silly if you think about it.
To take this to the absurd, my MIL just retired at 58 as a GS-15 with an inflation adjusted pension of say $115,000 [no SS]. She also has a small TSP worth, say, $100,000. If she did a PV calculation, she might find that the pension is equivalent to say $3,000,000 in TIPS [i didn't do any real calculation, I'm just ballparking it], so she'd roughly be 96% bonds and 4% stocks. Should she then borrow $1,302,000 to buy stocks to bring her asset allocation to 58% bonds and 42% stocks [her age in bonds]?

Now there is nothing wrong with saying "hey, i will have a rather large pension, so if I take more risk with my other investments and it doesn't turn out that good, I'm still going to be okay." But increasing the amount of money you invest in stocks or other risky things simply because you have a pension seems dumb to me.

- Alec
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Re: Defined Benefits Pension as fixed income?

Post by bobcat2 » Sat Jun 02, 2012 8:24 am

alec wrote: This issue comes up every so often, and IMHO your thinking above is a little misguided. To quoth myself from a 2011 conversation:
D Paul wrote:My allocation goal is 50/50 equities/bonds
I don't really think that this is your goal. Most people come up with this stock/bond allocation without doing any real calculations and base this decision on their risk tolerance, age, etc. For example, "I'm 60 and have a 'medium' tolerance for risk." Is this type of "analysis" really how one wants to base their retirement income on? I don't think so.

A goal would be "I want $30,000 in retirement income". Since you have a pension of $16,800 per year, you need $13,200 per year from your portfolio. Thus, you set up your portfolio [in stocks and bonds] to generate the $13,200. You can do this multiple ways, like through monte carlo simulations with various stock/bond %'s, TIPS ladders, life annuities, etc.

For arguments sake, let's say that you decide on an AA of 50/50 stocks/bonds to generate this $13,200. And when you take your pension into account, your overall AA is 20% stocks and 80% bonds. As sscritic has said in the past [IIRC], you should be just as happy with 50/50 ignoring the pension and 20/80 not ignoring the pension.

The AA of your [non-pension] portfolio is the end result of a whole bunch of calculations, not the starting point like "I think I should be 50/50 given my age and risk tolerance, so I should put 80% of my investment portfolio into stocks to take into account of my pension." IMHO, the latter is quite silly if you think about it.
To take this to the absurd, my (mother-in-law) just retired at 58 as a GS-15 with an inflation adjusted pension of say $115,000 [no SS]. She also has a small TSP worth, say, $100,000. If she did a PV calculation, she might find that the pension is equivalent to say $3,000,000 in TIPS [I didn't do any real calculation, I'm just ballparking it], so she'd roughly be 96% bonds and 4% stocks. Should she then borrow $1,302,000 to buy stocks to bring her asset allocation to 58% bonds and 42% stocks [her age in bonds]?

Now there is nothing wrong with saying "hey, I will have a rather large pension, so if I take more risk with my other investments and it doesn't turn out that good, I'm still going to be okay." But increasing the amount of money you invest in stocks or other risky things simply because you have a pension seems dumb to me.
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Re: Defined Benefits Pension as fixed income?

Post by Doc » Sat Jun 02, 2012 9:18 am

Dandy wrote: It is much better to count the pension as income and because your income is higher you can decide to take a higher level of risk in your investment portfolio rather than treat a fixed income stream as a bond.
OK the pension gives me an income floor so I have the ability to take on more risk. But by the same token the "guaranteed" income stream means I have less need to take income from my portfolio and therefore I can have a lower risk.

How can we possibly quantify the effect of the income stream when we don't even know the sign of the effect.

See also:

Should you buy a life annuity from SS
http://www.bogleheads.org/forum/viewtop ... 10&t=96945

and

Loan Paydown effect on AA
http://www.bogleheads.org/forum/viewtop ... 10&t=96345

which are some other recent threads on the effect of known income streams on AA.
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Re: Defined Benefits Pension as fixed income?

Post by sometimesinvestor » Sat Jun 02, 2012 5:35 pm

alec wrote:
fidelio wrote:
LadyGeek wrote:This discussion is already summarized in the wiki: Fixed income

Should we add defined benefits somewhere?
lady geek / taylor, mel / et al.:

perhaps. i'm not sure there is a consensus, but it's a huge issue for anyone attempting to set an a.a. who has either an employer's defined benefit payment or is collecting social security. probably most of the retired members of this forum possess or will possess at least one such monthly payment. i hope to be collecting both eventually, and counting these two factors as a bond investment would completely change, or skew, the amount of equities to be kept in my portfolio.
This question was the very first one I ever asked on this site and having followed it on many threads I agree it would be reasonable to adress in the wiki. Clearly the existence or nonexistence of heirs probably should influence your asset allocation if you have a reklatively generous pension.matters.My inclination now is to have set up a portfolio that will insure you have sufficient income but once you have that include more equities, inflation hedges etcbecause inflation may be your biggest danger.

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Re: Defined Benefits Pension as fixed income?

Post by Doc » Sat Jun 02, 2012 5:54 pm

sometimesinvestor wrote: My inclination now is to have set up a portfolio that will insure you have sufficient income but once you have that include more equities, inflation hedges etcbecause inflation may be your biggest danger.
There's the dilemma. Once you have sufficient income you don't need to take on more risk. But on the other hand you now have the ability to take on more risk.

As far as inflation is concerned, if you already have enough income just buy TIPS to maintain the real value of your portfolio ie go less riskier not more.

:?

Maybe the real question is what is "sufficient income"? If I have $50k income a month from SS/pension/annuities etc. and $1million in the bank I could invest that $1million with a Bain Capital for the grandchildren or put it in a TIPS fund for the grandchildren. The income doesn't help with my AA once I have "sufficient income".
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Re: Defined Benefits Pension as fixed income?

Post by pjstack » Sat Jun 02, 2012 7:30 pm

(Anecdote Alert)
Well, I used to think of my govt. pension as a bond, and around the beginning of 2008 I thought I was in the catbird seat!

I had an asset allocation of 80% stocks and 20% bonds. (I was 72 at the time.)

At the end of 2009 my asset allocation had been inadvertently "readjusted" by the market to somewhere around 50/50.

Yep, I sure had the ability to take risk (the stock market drop didn't ruin me) but I found out I didn't have the need and it turned out that my ability to cope with risk was a heckuva lot less than my previous bravado!

I no longer consider my pension to be a "bond" and my asset allocation is a bit more appropriate to my age.
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Re: Defined Benefits Pension as fixed income?

Post by gotherelate » Sat Jun 02, 2012 7:53 pm

Doc wrote:OK the pension gives me an income floor so I have the ability to take on more risk. But by the same token the "guaranteed" income stream means I have less need to take income from my portfolio and therefore I can have a lower risk.

How can we possibly quantify the effect of the income stream when we don't even know the sign of the effect.
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Re: Defined Benefits Pension as fixed income?

Post by LadyGeek » Sat Jun 02, 2012 8:10 pm

I did a little reorganizing and added yet another definition of fixed income to the wiki. How's this look? Fixed income

Comments / questions / concerns are welcome.
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Re: Defined Benefits Pension as fixed income?

Post by sscritic » Sat Jun 02, 2012 8:22 pm

pjstack wrote:(Anecdote Alert)
Well, I used to think of my govt. pension as a bond, and around the beginning of 2008 I thought I was in the catbird seat!

I had an asset allocation of 80% stocks and 20% bonds. (I was 72 at the time.)
So you had a pension worth $1 million. You counted it as a bond. Your other $4 million was invested 100% in stocks. That's what 80% stock/20% bond looks like when you count your pension as a $1 million bond. Now if your pension was a $2 million bond, then you had $8 million is stocks.

P.S. I am curious as to why you felt it was appropriate to be 80% stocks after counting your pension as a bond. My thought has always been that if I count my pension as a bond, my stock percentage of the whole package will be smaller (the pension being such a big bond).

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Re: Defined Benefits Pension as fixed income?

Post by pjstack » Sat Jun 02, 2012 9:14 pm

sscritic wrote:
pjstack wrote:(Anecdote Alert)
Well, I used to think of my govt. pension as a bond, and around the beginning of 2008 I thought I was in the catbird seat!

I had an asset allocation of 80% stocks and 20% bonds. (I was 72 at the time.)
So you had a pension worth $1 million. You counted it as a bond. Your other $4 million was invested 100% in stocks. That's what 80% stock/20% bond looks like when you count your pension as a $1 million bond. Now if your pension was a $2 million bond, then you had $8 million is stocks.

P.S. I am curious as to why you felt it was appropriate to be 80% stocks after counting your pension as a bond. My thought has always been that if I count my pension as a bond, my stock percentage of the whole package will be smaller (the pension being such a big bond).
Sorry to have misled. Yes, I did assume that if my pension was a bond paying 4% then yes, it would be worth a bond well over a million dollars. You have that part right, but (belive me) I had no where near "another $4 million" to invest!

I should have made clear that my rather paltry investible cash was split 80% stocks/20% bonds since I had the confidence that a "million dollar bond" gave me. (What could go wrong?)

And, I agree, if I actually had $4 million it would probably all be in bonds and I wouldn't have to worry my little head aboutany of this stuff.
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Re: Defined Benefits Pension as fixed income?

Post by 555 » Sat Jun 02, 2012 9:50 pm

Doc wrote:"There's the dilemma. Once you have sufficient income you don't need to take on more risk. But on the other hand you now have the ability to take on more risk."
That's not a dilemma. It just means you have a range of choices.

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Re: Defined Benefits Pension as fixed income?

Post by Dandy » Sun Jun 03, 2012 1:08 am

Wow - I really don't get it. I must be missing something. This is how I view it and it may not fit your circumstances.
1. To me pensions, social security and annuity type payments are income that is usually consumed in retirement.
2. They reduce the need for your retirement investements to provide living expenses and allow you to consider a higher allocation to equities.
3. Your retirement investments which are hopefully consumed at 4% or less need to have an allocation to equities, bonds
and/or cash.
4. That allocation should take into account your monthly expenses, inflation,your age, your health, your risk tolerance, your spouse's investment savy,risk tolerance and health, you desire to leave money to heirs, some contingency for unusual expenses esp. medical, life insurance, etc.
5. That allocation can vary from high to no risk depending on all those variables and more.
6. That retirement investment allocation should not include income streams that are consumed, just like non retireees shouldn't count their salaries as bonds in determining their investment asset allocation.
7. Trying to determine and maintain a bond equvalent value of a pension or other annuity payment is problematic (at least to me). Someone said 11X the annual payment. Why 11? Do you adjust the value as interest rates change?
8. I think it is much better/cleaner to focus on the allocation of the actual retirement investment portfolio based your risks/needs etc

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Re: Defined Benefits Pension as fixed income?

Post by fidelio » Sun Jun 03, 2012 2:32 am

LadyGeek wrote:I did a little reorganizing and added yet another definition of fixed income to the wiki. How's this look? Fixed income

Comments / questions / concerns are welcome.
l.g.: very good, at least it's addressed (one fn. directs the reader to this very thread, where they will be able to see the issue and diff. viewpoints on it). best, artie.

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Re: Defined Benefits Pension as fixed income?

Post by Valuethinker » Sun Jun 03, 2012 3:50 am

CJ

Your pension scheme, being Canadian Federal Government, will be CPI indexed.

Remember CPI tends to underperform pensioner's actual cost of living in the long run (pensioners don't buy many of the things which experience strong deflation like stereos).

I would work out what you need to retire in terms of income for standard of living. Don't forget CPP.

Then I would deduct your DB scheme.

You could then work out how much lump sum amount you need to purchase an annuity of that amount pa.

The practical impact of a DB scheme is that if it approaches your need, you can take greater risk in equities with your portfolio.

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Re: Defined Benefits Pension as fixed income?

Post by af895 » Sun Jun 03, 2012 8:05 am

Thanks to all those who have taken the (considerable) time to respond.

Yes, my pension is indexed to CPI. The monthly pension benefit by age 58 would be enough to live on comfortably with room for things like travel, entertainment, charity etc. I already live a frugal lifestyle and by that point I wouldn't be putting money into savings, freeing up a large chunk of monthly income.

I have no dependents or heirs. My spouse manages her finances separately from mine.

There doesn't seem to be a consensus on this topic but all positions have merit. At least now, I know some of the questions I should be asking, evening if I don't have answers.

Further discussion would be most welcome.

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Re: Defined Benefits Pension as fixed income?

Post by dbr » Sun Jun 03, 2012 9:52 am

CJOttawa wrote:Thanks to all those who have taken the (considerable) time to respond.

Yes, my pension is indexed to CPI. The monthly pension benefit by age 58 would be enough to live on comfortably with room for things like travel, entertainment, charity etc. I already live a frugal lifestyle and by that point I wouldn't be putting money into savings, freeing up a large chunk of monthly income.

I have no dependents or heirs. My spouse manages her finances separately from mine.

There doesn't seem to be a consensus on this topic but all positions have merit. At least now, I know some of the questions I should be asking, evening if I don't have answers.

Further discussion would be most welcome.
In this case the real question is what do you want to do with all that extra money.

Larry Swedroe has pointed out the possibly useful observation that marginal utility of wealth can be overestimated and risk can be underestimated, leading to suggesting less risky investment allocations than might otherwise be taken in cases like this. I doubt that how you count the pension, in or out of investments, will be enlightening regarding these questions.

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Re: Defined Benefits Pension as fixed income?

Post by texasdiver » Sun Jun 03, 2012 10:43 am

Defined benefit pensions are not fixed income investments, they are annuities.

Anyone with standard retirement portfolio can convert part or all of their nest egg into a fixed annuity that matches pretty much any type of defined benefit pension. You can buy inflation indexed annuities or fixed annuities or any of dozens of different flavors to match pretty much any pension out there.

There might be a rule of thumb for how much of your next egg you want to convert to annuities and how much you want to retain as an investment portfolio. I'm not sure what it is, but it has nothing to do with the "age in bonds" question or asset allocation.

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Re: Defined Benefits Pension as fixed income?

Post by dbr » Sun Jun 03, 2012 10:52 am

texasdiver wrote:
There might be a rule of thumb for how much of your next egg you want to convert to annuities and how much you want to retain as an investment portfolio. I'm not sure what it is, but it has nothing to do with the "age in bonds" question or asset allocation.
Good comments above, but there is no rule of thumb. There exist any number of retirement income models that can consider the alternative of annuitizing some assets or the effect of having a pension, SS, etc. You can't follow what is going to happen in retirement without taking the whole picture into account, and doing so by trying to "capitalize" income streams doesn't work very well.

Jim Otar considers the annuity issue in some sections of his book:

http://www.retirementoptimizer.com/

There are many others as well, and this resource might be helpful:

http://bobsfinancialwebsite.com/

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Re: Defined Benefits Pension as fixed income?

Post by Mr Grumpy » Mon Jun 04, 2012 10:20 am

Good thread. For every argument there is a counter argument. I respectfully disagree with Mr. Bogle though, personally I do not include my DP (or house) as part of my portfolio, but it can depend on why you track the portfolio. For me it's a gut check on my collection of investments and done for AA considerations. As others have pointed out, to count personal real estate and DP, it would have to have a determinative amount that exists for calculating purposes only and would have to be removed for financial or legal presentation to others.

If my lovely wife and I died on our Boglehead 'around the world tour' when the rubber band snapped somewhere over China, my will covers real estate and although my DP has survivor benefits, those benefits would not pass to children and would die with us.

Or worse, if I needed to get a loan and show net worth, although real estate would count, I'm sure any financial institution would count the pension as income and not on the portfolio side.

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Re: Defined Benefits Pension as fixed income?

Post by whaleknives » Sun Jan 13, 2013 3:23 am

I've been trying to reconcile John Bogle's "age in bonds"
". . . an investor's bond position should be equal to his or her age. . . 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 bond-like investments.)" Common Sense on Mutual Funds (2010, pp.87-88)
with the more aggressive stock/bond recommendations of today, by considering guaranteed income as "bond-like investments". I know from this and other threads that treating income as an asset is controversial, but bear with me.

If you take an expected income and estimate the present value with an immediate fixed annuity calculator like Vanguard's Income Solutions, then you have a lump sum you can add to bonds for an adjusted fixed income %, higher than bonds alone.

Image

So a near-retiree with a 70/30 stock/bond split, investments of $700k, a social security annuity of $700k, and total retirement funds of $1,400k now has an adjusted fixed income allocation of 65%, much closer to age.
Last edited by whaleknives on Sun Jan 27, 2013 1:16 pm, edited 5 times in total.
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Re: Defined Benefits Pension as fixed income?

Post by dbr » Sun Jan 13, 2013 9:42 am

whaleknives wrote:
So a near-retiree with a 70/30 stock/bond split, investments of $700k, a social security annuity of $700k, and total retirement funds of $1,400k now has an adjusted fixed income allocation of 65%, much closer to age.
The effect of Mr. Bogle's recommendation is that investors can have actual assets invested in a very risky portfolio and feel that this is OK. In fact, with a little finagling one can recommend actual assets be invested more than 100% in stocks, presumably using some kind of leverage. People are entitled to make of that whatever they will.

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Re: Defined Benefits Pension as fixed income?

Post by Bacchus01 » Sun Jan 13, 2013 1:06 pm

Fascinating discussion.

For those that are including pensions in their AA, what model are you using to discount it to present value?

In my case, I'll have a non-indexed pension worth about $36K a year from a former employer starting at age 65. I'm now 39. How would I value that to today's dollars?

For those that are not yet drawing SS, but would count something like that in your AA, how do you calculate that back to today's value for AA purposes?

Thanks.

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Re: Defined Benefits Pension as fixed income?

Post by ourbrooks » Sun Jan 13, 2013 2:07 pm

Bacchus01 wrote:Fascinating discussion.

For those that are including pensions in their AA, what model are you using to discount it to present value?

In my case, I'll have a non-indexed pension worth about $36K a year from a former employer starting at age 65. I'm now 39. How would I value that to today's dollars?

For those that are not yet drawing SS, but would count something like that in your AA, how do you calculate that back to today's value for AA purposes?

Thanks.
You can use the PV function in Excel. For the number of periods, use your life expectancy; if you're male, at age 65, it's about 17 years. For the rate of interest, use 5.3%, the long term average rate for 10 year Treasuries. That will give you the present value at age 65.

To get the value at age 39, assume an interest rate and then calculate the present value at age 39 of the amount you calculated for the present value at age 65.

Some things to note: The present value of a pension changes with age; that's logical since the older you are the fewer pension payments you would expect before you die.
Also, note that you need to make interest rate assumptions in two places, once for calculating the value at age 65 and again for age 39 to 65. Probably, they ought to be the same.

Sometimes you'll hear approximations like "a pension is worth X times the annual payments." Hidden behind these rules of thumbs are assumptions about interest rates and longevity.

You can apply the same approach to calculating Social Security, but it's much more complicated. Social Security is at least three things: it's dual life pension, since payments last until both members of couple die; it's a single life annuity on the primary beneficiary since the spouse stops receiving the spousal benefit when the primary beneficiary dies, and there's also the dependent benefit. Probably, only the first two need to be calculated.

Personally, I don't consider pensions or Social Security in my asset allocations, in part, because of all the assumptions and calculations you have to make to get a reasonable answer and the fact that you can't rebalance into or out of them.

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Re: Defined Benefits Pension as fixed income?

Post by af895 » Sun Jan 13, 2013 7:08 pm

It's interesting to see this thread come up again.
ourbrooks wrote:...Personally, I don't consider pensions or Social Security in my asset allocations, in part, because ...you can't rebalance into or out of them.
I've come full circle on this topic with the above comment mirroring my thinking of late.

While my risk tolerance is very high (I'd relish a prolonged market depression in which to buy assets at a discount) I've elected to set my asset allocation to 25% fixed income/75% equity. (split three ways - domestic Canadian, US, international) largely to have something to rebalance into and out of.

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Re: Defined Benefits Pension as fixed income?

Post by JW-Retired » Sun Jan 13, 2013 9:17 pm

CJOttawa wrote: It's interesting to see this thread come up again.
ourbrooks wrote:...Personally, I don't consider pensions or Social Security in my asset allocations, in part, because ...you can't rebalance into or out of them.
I've come full circle on this topic with the above comment mirroring my thinking of late.

While my risk tolerance is very high (I'd relish a prolonged market depression in which to buy assets at a discount) I've elected to set my asset allocation to 25% fixed income/75% equity. (split three ways - domestic Canadian, US, international) largely to have something to rebalance into and out of.
Are we talking a different language? I don't count "pensions or Social Security in my asset allocations" either. I certainly do take them into account in deciding what I want for an AA in my investible assets nest egg. That's the AA I rebalance. This "forget about the pension because you can't rebalance it" makes no sense to me. Neither does you decided 25% bonds for this reason.

I hope you could explain CJOttawa because this majority Boglehead approach totally escapes me and always has. They always say I have this because of that, but the this can be almost any number. How exactly did you decide your chosen 75/25 AA? Is this age in bonds? age -10? What is it and why? Does your pension/SS come into it in any way?
thanks,
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Re: Defined Benefits Pension as fixed income?

Post by BTDT » Sun Jan 13, 2013 10:03 pm

I include my two govt. cola adjusted pensions and social security when choosing my asset allocation split, but I don't have a magic number. Knowing I can lose all my equities and bonds and still get by, I tend to take a little more risk with equities at this particular time in life (age 66).
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Re: Defined Benefits Pension as fixed income?

Post by ourbrooks » Sun Jan 13, 2013 10:05 pm

For me, it's simple: Over rolling five year periods, stocks have lost money 40% of the time. That's too high for money I need in five years; I put that money all in bonds. Stocks have never lost money in any rolling 20 year period; money I don't need for 20 years I keep in stocks. Everything in between I allocate proportionally between 0% and 100% stocks based on the when I think I'll need it. (I actually do the calculations for five year periods.) There are also some considerations for funds for which I don't know if/when I'll need the money, such as long term care expenses, and for money which I never hope to need, such as bequests.

I suppose I could roll the different time periods and expenses categories into one big X% stocks/Y% bonds number but it wouldn't mean much.

Social Security, pensions, home equity, etc. and age certainly play a role in determining when I need the money but they don't impact the percentage of high/low volatility assets directly.

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Re: Defined Benefits Pension as fixed income?

Post by Valuethinker » Mon Jan 14, 2013 4:17 am

Bacchus01 wrote:Fascinating discussion.

For those that are including pensions in their AA, what model are you using to discount it to present value?

In my case, I'll have a non-indexed pension worth about $36K a year from a former employer starting at age 65. I'm now 39. How would I value that to today's dollars?

For those that are not yet drawing SS, but would count something like that in your AA, how do you calculate that back to today's value for AA purposes?

Thanks.
Look up what an annuity of that amount would cost a 65 year old.

Then discount back by 3% pa (LT US Treasury rate + a bit). If there is a corporate bond for the plan sponsor (employer) you could use *that* discount rate (or the average for S&P/ Moody's rated companies of that credit rating). that ignores the benefit of the PBGC, which is a government sponsored programme (but would, I believe, inflict some benefit cuts if it were to take over the plan). I am pretty happy with 3%.

Rule of thumb is 12x benefit for a flat annuity, 25x for a CPI indexed one then discount back. The above approach is more accurate.

Neither approach is anything more than an approximation.

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