SS/Pension/etc as bond allocation?

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andrew99999
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SS/Pension/etc as bond allocation?

Post by andrew99999 » Thu Jan 10, 2019 11:40 pm

I read somewhere on here recently that you can consider a guaranteed payment to be part of your bonds, and therefore reduce your bonds percentage.

I was wondering if anyone can offer a formula for this?

For example, say you had the following

Had 1m portfolio
4% withdrawal rate
50/50

If you then throw in the same person getting inflation adjusted 10k/yr guaranteed (SS/pension/etc), specifically how would you change the AA to include this?

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Nestegg_User
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Re: SS/Pension/etc as bond allocation?

Post by Nestegg_User » Fri Jan 11, 2019 1:21 am

OP, you've been here long enough to know... pension is income/cash flow, it has nothing to do with bonds in your portfolio... it simply means that the portfolio won't need to supply as much in your retirement

so if you've got your 1M$ (Aussie) getting you 35 k $ (Aussie)/year (using a more conservative 3.5% value for non-US portfolio), in having a pension at 10k $ (Aussie) your returns don't need to be as high to insure you could survive the 30 years. That may be good since most Oz stocks seem to be either natural resources (ore, etc) or banking stocks, and are more prone to cyclical behavior; you might also be concerned with exchange rates for your holdings, since you would be more concerned with China ( as a major importer of your goods) than a US- based investor. (remember that Oz stocks seem to have a significantly higher volatility: ~24% std dev vs ~15% for US, likely part of the reason for a lower expected SWR)

Estrada gives a failure rate of 17.4% for a 50/50 portfolio for Australia (period 1900-2014), which drops to 7% for a 70/30 portfolio, in his paper "From Failure to Success: Replacing the Failure Rate" {SSRN id2954549}

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andrew99999
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Re: SS/Pension/etc as bond allocation?

Post by andrew99999 » Fri Jan 11, 2019 1:58 am

Thanks for your response.

It wasn't a question specific to region or asset allocation or withdrawal rate, so you can change it to any other allocation and withdrawal rate if it helps. I just used those as an example. The question is just whether (and how) one might adjust their AA based on some guaranteed income compared to none.

james22
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Re: SS/Pension/etc as bond allocation?

Post by james22 » Fri Jan 11, 2019 2:52 am

Nestegg_User wrote:
Fri Jan 11, 2019 1:21 am
OP, you've been here long enough to know...
And you've been here long enough to know this question is never settled. :happy
This whole episode is likely to end so badly that future children will learn about it in school and shake their heads in wonder at the rank stupidity of it all... Hussman

IFYOUCAN
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Re: SS/Pension/etc as bond allocation?

Post by IFYOUCAN » Fri Jan 11, 2019 3:29 am

More for people who haven't got enough to live on? so they go more aggressive on their portfolio? for example an Aussie couple who retire with only $250k and get full pension.
Does this help?
https://youtu.be/IC1seH7Z42I

Valuethinker
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Re: SS/Pension/etc as bond allocation?

Post by Valuethinker » Fri Jan 11, 2019 4:27 am

andrew99999 wrote:
Thu Jan 10, 2019 11:40 pm
I read somewhere on here recently that you can consider a guaranteed payment to be part of your bonds, and therefore reduce your bonds percentage.

I was wondering if anyone can offer a formula for this?

For example, say you had the following

Had 1m portfolio
4% withdrawal rate
50/50

If you then throw in the same person getting inflation adjusted 10k/yr guaranteed (SS/pension/etc), specifically how would you change the AA to include this?
Andrew

You are right to think this significantly reduces risk for retirement planning purposes.

UK pensions (career average or final salary) are all indexed to either RPI (higher) or CPI inflation up to 5% p.a. 50% spousal survivor benefit is a legal requirement.

The HMRC (tax authority) formula is to count that benefit as 20x in terms of lifetime £1m pension limit. I.e. a pension of £10k pa at 65 would be £200k reducing your "headroom" to 800k.

If you look at the index linked gilt (inflation linked bond aka "TIPS" in US) market, actually buying that benefit would require something like 30-35x, although if you factor in the difference on a CPI pension v. RPI linked bonds (about 1.0% lower increase pa for the CPI pension*) then it would be 30x or above.

So one could split the difference.

Take 25x the benefit. 250k for your 10k pa.

If *not* inflation indexed then the multiplier is far less - I would say something like 10x.

I think the actual actuarial rule is 20x the benefit at age 65, then discount back to your current age. So £10k pa would be worth £200k but if you are 35 discount back by 30 years. Since we are doing this in real terms and index linked gilts have a c. -1.6% yield right now (RPI linked) that's tricky -- if I do it in sterling nominal terms that's c. 1.6% yield on long gilts. You could simply say "discount at 0% real" and make it easy ;-). But probably 1-2%.

I am in my 50s, so just counting it as 20x (as HMRC will do) works for me. For me it's helpful insurance if my investments don't work out, and it's especially helpful if my partner (female) lives to be 95 (I suspect she has something like a 50% chance of doing that - if you avoid the lifestyle bad things of tobacco alcohol & eat a fibre and plant-based diet (and don't suffer from financial deprivation) then you have a reasonable chance of living to your natural span which seems to be, for the average rich country person's genetics, 95-100; being male whacks about 10 years off that right there ;-)).

The other way to do it is to try to model retirement expenses then count that income as a reduction in those expenses i.e. as needing less to hit your retirement number.

BTW I don't believe 4% as a SWR. "Safe" implies, to me, negligible possibility of exhaustion of funds (that 95 year life expectancy thing - Andrew Scott and Linda Gratton of London Business School have written a book about "the 100 year old world" the consequences of increased longevity for careers, financial planning & government finances - Japan is in that world, now, and we will follow it**). I think at today's gilt yields, at least, the real number is c. 2% (maybe 2.5%) although I have not seen it modeled.

* Retail Price Index is what was historically calculated but continues in many areas of life due to legal contracts or government policy. Consumer Price Index is the internationally comparable number, and is what the Bank of England targets for inflation (2% +/- 1% band).

** barring a major shift re disease, antibiotic resistance etc - which is quite possible. Also the rising obesity ("crisis" is not too strong a word) and type 2 diabetes in the western world is going to seriously increase morbidity (if not mortality). On the other hand, if medical science cracks the latter - you are definitely seeing countries begin to treat it as they have attacked smoking in the last 50 years - when Britain brought in the indoor smoking ban it seemed unimaginable (no smoking in pubs? ) and now it's just an accepted norm - then turning that really *will* compound the demographic crisis.

Topic Author
andrew99999
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Re: SS/Pension/etc as bond allocation?

Post by andrew99999 » Fri Jan 11, 2019 6:05 am

Valuethinker wrote:
Fri Jan 11, 2019 4:27 am
So one could split the difference.

Take 25x the benefit. 250k for your 10k pa.
Yeah that was what I was thinking it might be.

So in the example of someone with 1mil planning on 50/50 with 4% withdrawals (just as example figures), a 10k inflation linked guaranteed income would then mean you essentially have 250k covered, so you would then be able to consider the 750k as 50/50 and then dump the rest into "risky" assets and consider yourself equally financially "safe".
james22 wrote:
Fri Jan 11, 2019 2:52 am
Nestegg_User wrote:
Fri Jan 11, 2019 1:21 am
OP, you've been here long enough to know...
And you've been here long enough to know this question is never settled. :happy
Ah, maybe that is why I didn't quite get why I've been here long enough to know. I probably glossed over the topics about SS/pension and just haven't see it and so didn't realise it was one of those questions that has no definitive answer. I will have to look out for more discussions of it then. Do you by any chance know search keywords to use to look for other discussions on it?

delamer
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Re: SS/Pension/etc as bond allocation?

Post by delamer » Fri Jan 11, 2019 11:25 am

If you received all the retirement income that you need from guaranteed income streams (like pensions, annuities, Social Security), how would you invest your portfolio?

2pedals
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Re: SS/Pension/etc as bond allocation?

Post by 2pedals » Fri Jan 11, 2019 11:40 am

andrew99999 wrote:
Thu Jan 10, 2019 11:40 pm
I read somewhere on here recently that you can consider a guaranteed payment to be part of your bonds, and therefore reduce your bonds percentage.

I was wondering if anyone can offer a formula for this?

For example, say you had the following

Had 1m portfolio
4% withdrawal rate
50/50

If you then throw in the same person getting inflation adjusted 10k/yr guaranteed (SS/pension/etc), specifically how would you change the AA to include this?
I wouldn't change a thing. Say, if I had a inflation adjusted 200k+/yr the 1m goes to 50% bonds / 50% TIPS and no equity.

Maverick3320
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Re: SS/Pension/etc as bond allocation?

Post by Maverick3320 » Fri Jan 11, 2019 11:45 am

james22 wrote:
Fri Jan 11, 2019 2:52 am
Nestegg_User wrote:
Fri Jan 11, 2019 1:21 am
OP, you've been here long enough to know...
And you've been here long enough to know this question is never settled. :happy
He's also been here long enough to have 99998 other people named "Andrew" grab a username before him...

Valuethinker
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Re: SS/Pension/etc as bond allocation?

Post by Valuethinker » Fri Jan 11, 2019 11:49 am

andrew99999 wrote:
Fri Jan 11, 2019 6:05 am
Valuethinker wrote:
Fri Jan 11, 2019 4:27 am
So one could split the difference.

Take 25x the benefit. 250k for your 10k pa.
Yeah that was what I was thinking it might be.

So in the example of someone with 1 mil planning on 50/50 with 4% withdrawals (just as example figures), a 10k inflation linked guaranteed income would then mean you essentially have 250k covered, so you would then be able to consider the 750k as 50/50 and then dump the rest into "risky" assets and consider yourself equally financially "safe".
Or rather

250k = bond equivalent of future pension (inflation indexed)

250k - invest in bonds (inflation indexed)

500k - invested in equities

Is consistent with 50/50 bond/ equity without pension income

Is that what you meant?

HOWEVER

- the 10k had better be risk free - companies go broke, governments change their policies. US rules are different (PBGC protects nominal pensions but not real) but say in Canada there seems to be nothing (Nortel went broke, people lost a large fraction of their pensions), UK has the PPF (which does make cuts in benefits) but it's never been tested in a really bad string of bankruptcies of pension plan sponsors (employers). US public sector (state and local) has real issues too -- depending on your location.

- you should discount that 250k back to the present day. Doing it in real terms is tricky but say at 2% real to get an equivalent lump sum (on the basis that interest rates will eventually revert to 2% real). So 30 years say at 2% (or 1% which is closer to the long term real fixed income return).

I know what the deficit is on the final salary scheme from the 1990s of which I am a member, is. I am, fortunately, not reliant on it, and I *think* it will be paid (the benefit is sufficiently small that even a resolution to the PPF would still leave most of it intact) - if I lost some or all of it, that would be a blow (especially to my spouse who might easily live another 40 years) but it won't finish us - we would just have to tap the home equity sooner than planned.

Valuethinker
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Re: SS/Pension/etc as bond allocation?

Post by Valuethinker » Fri Jan 11, 2019 11:50 am

Maverick3320 wrote:
Fri Jan 11, 2019 11:45 am
james22 wrote:
Fri Jan 11, 2019 2:52 am
Nestegg_User wrote:
Fri Jan 11, 2019 1:21 am
OP, you've been here long enough to know...
And you've been here long enough to know this question is never settled. :happy
He's also been here long enough to have 99998 other people named "Andrew" grab a username before him...
I am especially partial to posts by Andrew666 ... ;-).

305pelusa
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Re: SS/Pension/etc as bond allocation?

Post by 305pelusa » Fri Jan 11, 2019 1:01 pm

andrew99999 wrote:
Fri Jan 11, 2019 6:05 am
Valuethinker wrote:
Fri Jan 11, 2019 4:27 am
So one could split the difference.

Take 25x the benefit. 250k for your 10k pa.
Yeah that was what I was thinking it might be.

So in the example of someone with 1mil planning on 50/50 with 4% withdrawals (just as example figures), a 10k inflation linked guaranteed income would then mean you essentially have 250k covered, so you would then be able to consider the 750k as 50/50 and then dump the rest into "risky" assets and consider yourself equally financially "safe".

Wait not quite. The extra 250k would be invested in a 50/50 AA and then that would be equivalent. So the final asset allocation would be (500+125)/(1Mil) -> 62.5/37.5. That would be ~ equivalent to 625k in stocks, and 375k in bonds plus the pension (which you estimate to be 250k).

Idk how realistic a pension can be thought of as a 250kbond here but just wanted to clear the math.

dbr
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Re: SS/Pension/etc as bond allocation?

Post by dbr » Fri Jan 11, 2019 1:17 pm

305pelusa wrote:
Fri Jan 11, 2019 1:01 pm

Idk how realistic a pension can be thought of as a 250kbond here but just wanted to clear the math.
Since a pension is not a bond there is no math to clear.

There is a process to follow however. That process is to consider the pension to be what it is, which is a lifetime income stream in real or nominal dollars and at some risk of default and then see what amount of risk in investments one has the need, ability, and willingness to take. That process is mainly one of being thoughtful with an understanding of how investments behave than it is of applying formulas. Things like safe withdrawal rate analysis, maximum drawdown analysis, etc. may offer some quantitative guidance, but in the end it is all personal judgement and preference.

Dandy
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Re: SS/Pension/etc as bond allocation?

Post by Dandy » Fri Jan 11, 2019 1:31 pm

Did you count your salary as a bond? If you want to take more risk -- take it. Having a pension allows you to take a bit more risk if you desire. You don't need to convert an income stream into pseudo bond.

dbr
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Re: SS/Pension/etc as bond allocation?

Post by dbr » Fri Jan 11, 2019 1:43 pm

Dandy wrote:
Fri Jan 11, 2019 1:31 pm
Did you count your salary as a bond? If you want to take more risk -- take it. Having a pension allows you to take a bit more risk if you desire. You don't need to convert an income stream into pseudo bond.
Indeed so. Part of the process of need/ability/willingness includes the case of young people who have ability to take risk because they can look forward toa long period of earning money. That opportunity also has risks, such as job loss, disability, etc.

2pedals
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Re: SS/Pension/etc as bond allocation?

Post by 2pedals » Fri Jan 11, 2019 2:33 pm

dbr wrote:
Fri Jan 11, 2019 1:43 pm
Dandy wrote:
Fri Jan 11, 2019 1:31 pm
Did you count your salary as a bond? If you want to take more risk -- take it. Having a pension allows you to take a bit more risk if you desire. You don't need to convert an income stream into pseudo bond.
Indeed so. Part of the process of need/ability/willingness includes the case of young people who have ability to take risk because they can look forward toa long period of earning money. That opportunity also has risks, such as job loss, disability, etc.
On the other hand a secure pension in retirement allows you to sleep well at night (SWAN) dropping the need/desire to take on more risk.

dbr
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Re: SS/Pension/etc as bond allocation?

Post by dbr » Fri Jan 11, 2019 2:40 pm

2pedals wrote:
Fri Jan 11, 2019 2:33 pm
dbr wrote:
Fri Jan 11, 2019 1:43 pm
Dandy wrote:
Fri Jan 11, 2019 1:31 pm
Did you count your salary as a bond? If you want to take more risk -- take it. Having a pension allows you to take a bit more risk if you desire. You don't need to convert an income stream into pseudo bond.
Indeed so. Part of the process of need/ability/willingness includes the case of young people who have ability to take risk because they can look forward toa long period of earning money. That opportunity also has risks, such as job loss, disability, etc.
On the other hand a secure pension in retirement allows you to sleep well at night (SWAN) dropping the need/desire to take on more risk.
Yes, it is an illustration of the fact that the presence of a pension does not have a definitive effect on what an investor chooses to do. Larry Swedroe has added the comment that when need is low but ability is high that the trump card is to take no more risk than necessary. His comment has been that the marginal utility of wealth is diminishing and that risk is most often underestimated.

One impact of having significant fixed pension income is that withdrawals from other resources have to increase faster than inflation to keep the total even with inflation. That is one aspect in which SWR portfolio studies are already too simple. Serious models such as many out there do take this sort of thing into consideration.

CurlyDave
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Re: SS/Pension/etc as bond allocation?

Post by CurlyDave » Fri Jan 11, 2019 7:14 pm

Nestegg_User wrote:
Fri Jan 11, 2019 1:21 am
OP, you've been here long enough to know... pension is income/cash flow, it has nothing to do with bonds in your portfolio... it simply means that the portfolio won't need to supply as much in your retirement ...
But I have been here long enough to realize that Jack Bogle himself recommends treating pensions and SS as the equivalent of bonds for AA purposes.

Because we have significant pensions and SS DW and I have a very aggressive AA, even in retirement. Whether we get there by treating income streams as "phantom bonds" or by just saying we have a very high risk tolerance is immaterial. Both roads lead to the same place.

The difference in the two roads is that it is mathematically easy to capitalize income streams at 20x or 25x and develop an AA, just saying we have high risk tolerance does not give any guidance on an appropriate AA. So, it is a good rule of thumb, even if it is not 100% precisely correct.

JoeRetire
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Re: SS/Pension/etc as bond allocation?

Post by JoeRetire » Fri Jan 11, 2019 8:20 pm

andrew99999 wrote:
Thu Jan 10, 2019 11:40 pm
I read somewhere on here recently that you can consider a guaranteed payment to be part of your bonds, and therefore reduce your bonds percentage.
You can consider a banana as an apple if you like. That doesn't make it the truth.

Guaranteed payments (I assume you are talking about Social Security, pensions, and perhaps some annuities) are not bonds.

They are income streams. As such they can reduce the amount of income you need from your stocks and bonds.

Topic Author
andrew99999
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Re: SS/Pension/etc as bond allocation?

Post by andrew99999 » Fri Jan 11, 2019 10:49 pm

Thanks to all for the replies. I haven't responded individually but I appreciate your input.
I'm glad I made this thread. Very polarising views, but I prefer that since it lets me understand all points of view of which to make a decision on rather than just seeing one point of view and not realising there are alternatives and different points to weigh up.

Topic Author
andrew99999
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Re: SS/Pension/etc as bond allocation?

Post by andrew99999 » Fri Jan 11, 2019 10:50 pm

Valuethinker wrote:
Fri Jan 11, 2019 11:49 am
andrew99999 wrote:
Fri Jan 11, 2019 6:05 am
Valuethinker wrote:
Fri Jan 11, 2019 4:27 am
So one could split the difference.

Take 25x the benefit. 250k for your 10k pa.
Yeah that was what I was thinking it might be.

So in the example of someone with 1 mil planning on 50/50 with 4% withdrawals (just as example figures), a 10k inflation linked guaranteed income would then mean you essentially have 250k covered, so you would then be able to consider the 750k as 50/50 and then dump the rest into "risky" assets and consider yourself equally financially "safe".
Or rather

250k = bond equivalent of future pension (inflation indexed)

250k - invest in bonds (inflation indexed)

500k - invested in equities

Is consistent with 50/50 bond/ equity without pension income

Is that what you meant?
Ah yea .. that makes much more sense.
So with the extra 250k left over, if you wanted to be more aggressive, you would then have 750 in equities and 250 in bonds, so moving up from a 50/50 to a 75/25 (if you so choose to be more aggressive).
Valuethinker wrote:
Fri Jan 11, 2019 11:49 am
HOWEVER

- the 10k had better be risk free - companies go broke, governments change their policies. US rules are different (PBGC protects nominal pensions but not real) but say in Canada there seems to be nothing (Nortel went broke, people lost a large fraction of their pensions), UK has the PPF (which does make cuts in benefits) but it's never been tested in a really bad string of bankruptcies of pension plan sponsors (employers). US public sector (state and local) has real issues too -- depending on your location.

- you should discount that 250k back to the present day. Doing it in real terms is tricky but say at 2% real to get an equivalent lump sum (on the basis that interest rates will eventually revert to 2% real). So 30 years say at 2% (or 1% which is closer to the long term real fixed income return).

I know what the deficit is on the final salary scheme from the 1990s of which I am a member, is. I am, fortunately, not reliant on it, and I *think* it will be paid (the benefit is sufficiently small that even a resolution to the PPF would still leave most of it intact) - if I lost some or all of it, that would be a blow (especially to my spouse who might easily live another 40 years) but it won't finish us - we would just have to tap the home equity sooner than planned.
Yes all good and important points. Thank you.

Valuethinker
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Re: SS/Pension/etc as bond allocation?

Post by Valuethinker » Sat Jan 12, 2019 9:44 am

Andrew again to interpret.

If you have 250k equivalent from a pension and you want to be 75 per cent in equities then you put 750k into equities.

I think that is what you mean?

Note there is no rebalancing there. You can add bonds as you continue to accumulate.

I would suggest that even in that position you should have at least 75k and up to 150k in bonds.

Because correlation is less than 1.0 you reduce total returns by much less than you would think. And you reduce volatility by quite a lot.

I believe valuation does matter and so in the run-up to 2000 you would have been selling stocks and buying them on the way down.

Valuethinker
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Re: SS/Pension/etc as bond allocation?

Post by Valuethinker » Sat Jan 12, 2019 9:57 am

Last thing. Currency may matter.

If your pension is in AUD say that might tilt you other assets allocated away from AUD.

The real clincher is is that pension inflation indexed. If it is it should mostly compensate you for falls in AUD over the long run.

As you know from other threads I am a bear on CAD and AUD relative to USD and Renimbi at least.

One issue is persistent current account deficits. We live off imported capital.

Besides huge housing bubbles I see 2 economies heavily dependent on fossil fuels extraction.

Natural gas that is a 30 year plus worry. But it's such a clean fuel that just switching India China Pakistan etc to NG is cleaning up energy production and consumption. I think the stat is that of the 20 worst air pollution cities in the world, 10 of them are Indian.

Canada has as much oil reserves as Saudi Arabia but it is the world's dirtiest oil and makes Canada one of the most polluting countries per capita in the world. And US fracked oil competes directly with it. Tar sands oil is the world's most expensive to produce and the Americans now have cheaper domestic resources.

Australia is much more about coal and that is a risk right now. Even though it may take 20 years before it really starts to bite: global restrictions on coal for electricity generation. Metallurgical coal extraction will of course continue for the foreseeable future.

Other Australian natural resources are very much in demand and the more so as Asia develops.

JW-Retired
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Re: SS/Pension/etc as bond allocation?

Post by JW-Retired » Sat Jan 12, 2019 11:10 am

CurlyDave wrote:
Fri Jan 11, 2019 7:14 pm
Nestegg_User wrote:
Fri Jan 11, 2019 1:21 am
OP, you've been here long enough to know... pension is income/cash flow, it has nothing to do with bonds in your portfolio... it simply means that the portfolio won't need to supply as much in your retirement ...
But I have been here long enough to realize that Jack Bogle himself recommends treating pensions and SS as the equivalent of bonds for AA purposes.

Because we have significant pensions and SS DW and I have a very aggressive AA, even in retirement. Whether we get there by treating income streams as "phantom bonds" or by just saying we have a very high risk tolerance is immaterial. Both roads lead to the same place.

The difference in the two roads is that it is mathematically easy to capitalize income streams at 20x or 25x and develop an AA, just saying we have high risk tolerance does not give any guidance on an appropriate AA. So, it is a good rule of thumb, even if it is not 100% precisely correct.
I also get fairly close to the same portfolio AA result for both methods: (1) Jack Bogle's mathematical recommendation (using your true age), and (2) Boglehead's think about everything financial .... then grab an AA out of the air. The two are starting to drift apart some as I age since I'm sticking to a Boglehead 60/40 real AA for the duration.
JW
ps: there is an old AA versus age poll that's interesting.
http://www.bogleheads.org/forum/viewtop ... 2#p1224012
Retired at Last

csmath
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Re: SS/Pension/etc as bond allocation?

Post by csmath » Sat Jan 12, 2019 11:22 am

I asked a similar question a little while back. I found the responses worthwhile considering.

viewtopic.php?f=1&t=263046

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