AA - Capitalized Value of An Investors Social Security

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
User avatar
Topic Author
framus
Posts: 171
Joined: Sun Mar 24, 2019 1:57 pm

AA - Capitalized Value of An Investors Social Security

Post by framus »

In this short out-take of a 2010 interview with John Bogle he refers to taking into account the capitalized value of one's Social Security when determining asset allocation:
https://youtu.be/BAqlll-vMjQ

How does one determine the capitalized value of one's Social Security?
-Framus
QBoy
Posts: 218
Joined: Sun May 05, 2013 7:09 am

Re: AA - Capitalized Value of An Investors Social Security

Post by QBoy »

Because real interest rates are about zero, you can simply multiply your yearly benefit by your remaining life expectancy.
User avatar
nisiprius
Advisory Board
Posts: 52216
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: AA - Capitalized Value of An Investors Social Security

Post by nisiprius »

Despite John C. Bogle's endorsement, I don't think this makes sense.

What you need in retirement is an income. Social Security reduces the amount of income your portfolio needs to support.

The simple, direct way to approach is to subtract Social Security (and other guaranteed income sources) from needed income, to get the amount of income you need to get from your portfolio of securities, and work from their.

It is going all round Robin Hood's barn and folding in bunches of estimates and assumptions and predictions, all of which logically ought to cancel each other out, to try to convert a guaranteed future income stream into the equivalent of a lump sum amount of bonds today so that you can try to estimate what income it will provide in the future.

And another reason it doesn't make sense is that all of the bonds in your portfolio are marketable securities which can be bought, sold, and rebalanced, and you mixing into it something which is none of those things.
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: 10726
Joined: Tue Aug 02, 2011 5:23 pm
Location: East of the Pecos, West of the Mississippi

Re: AA - Capitalized Value of An Investors Social Security

Post by bertilak »

nisiprius wrote: Fri Jun 24, 2022 6:21 pm Despite John C. Bogle's endorsement, I don't think this makes sense.

What you need in retirement is an income. Social Security reduces the amount of income your portfolio needs to support.

The simple, direct way to approach is to subtract Social Security (and other guaranteed income sources) from needed income, to get the amount of income you need to get from your portfolio of securities, and work from their.

It is going all round Robin Hood's barn and folding in bunches of estimates and assumptions and predictions, all of which logically ought to cancel each other out, to try to convert a guaranteed future income stream into the equivalent of a lump sum amount of bonds today so that you can try to estimate what income it will provide in the future.

And another reason it doesn't make sense is that all of the bonds in your portfolio are marketable securities which can be bought, sold, and rebalanced, and you mixing into it something which is none of those things.
Best synopsis of this I've read. I have tried to say the same thing several times and it all comes out complicated. The above is simple and straightforward. Once read there is no need to ask about it again!

But, I will add something anyway: People ask this question because they have read about recommended, or average, or sample Asset Allocations and want to match those numbers. That is a mistake because the person provoking those numbers knows nothing of your unique situation and that is critical input needed to come up with useful numbers.
May neither drought nor rain nor blizzard disturb the joy juice in your gizzard. -- Squire Omar Barker (aka S.O.B.), the Cowboy Poet
SGM
Posts: 3341
Joined: Wed Mar 23, 2011 4:46 am

Re: AA - Capitalized Value of An Investors Social Security

Post by SGM »

Capitalizing the value of Social Security, while interesting is not a good idea for planning asset allocation. I look at the income from our delayed until 70 Social Security, a pension, an annuity, and farm rental income as basically permanent income, some of which has built in increases for inflation. By adding up the various income streams I calculate that I will need very little income from our portfolios. I either spend from these income streams or if it is not needed, I reinvest the income.

I often receive the capitalized value of various farm income streams that people want to buy. I have no desire to sell any of these streams, so the capitalized value offers are always thrown away, I wouldn't use the capitalized value of any of these income streams to determine AA.
dbr
Posts: 46181
Joined: Sun Mar 04, 2007 8:50 am

Re: AA - Capitalized Value of An Investors Social Security

Post by dbr »

bertilak wrote: Fri Jun 24, 2022 6:56 pm
But, I will add something anyway: People ask this question because they have read about recommended, or average, or sample Asset Allocations and want to match those numbers. That is a mistake because the person provoking those numbers knows nothing of your unique situation and that is critical input needed to come up with useful numbers.
I agree. Fitting to an asset allocation formula and trying to capitalize income streams to do it means on the face of it that something is out of whack.

Before capitalizing income streams one needs to ask how one is arriving at asset allocation in the first place.
User avatar
Topic Author
framus
Posts: 171
Joined: Sun Mar 24, 2019 1:57 pm

Re: AA - Capitalized Value of An Investors Social Security

Post by framus »

nisiprius wrote: Fri Jun 24, 2022 6:21 pm Despite John C. Bogle's endorsement, I don't think this makes sense.

What you need in retirement is an income. Social Security reduces the amount of income your portfolio needs to support.

The simple, direct way to approach is to subtract Social Security (and other guaranteed income sources) from needed income, to get the amount of income you need to get from your portfolio of securities, and work from their.

It is going all round Robin Hood's barn and folding in bunches of estimates and assumptions and predictions, all of which logically ought to cancel each other out, to try to convert a guaranteed future income stream into the equivalent of a lump sum amount of bonds today so that you can try to estimate what income it will provide in the future.

And another reason it doesn't make sense is that all of the bonds in your portfolio are marketable securities which can be bought, sold, and rebalanced, and you mixing into it something which is none of those things.
Thanks. The Bogle capitalization of one's income stream was not something I'd seen mentioned previously.
I'm pretty much 50% Equities (VTSAX) - 45% Bonds (VBTLX) - 5% Cash and using RMD's to move, over time, to 45% Equities 50% Bonds. The Bogle capitalization concept could incline me to get far more aggressive in shifting to more Equities. At 77 that isn't something I see a need for.

Despite the angst that is being expressed about Bonds they have served as a reasonable shock absorber. I avoid thinking of bonds as ballast. Ballast will aid in sinking a hull that has been holed.
dbr
Posts: 46181
Joined: Sun Mar 04, 2007 8:50 am

Re: AA - Capitalized Value of An Investors Social Security

Post by dbr »

framus wrote: Sat Jun 25, 2022 2:04 pm
Despite the angst that is being expressed about Bonds they have served as a reasonable shock absorber. I avoid thinking of bonds as ballast. Ballast will aid in sinking a hull that has been holed.
Right. Someone commented that adding ballast reduces buoyancy and also freeboard. While the ship may be less prone to capsize there are serious offsets. Sagging under heavy loading might break the keel as well.

It is really better to just do the math that describes what happens to portfolios of stocks and bonds and not call it anything.
User avatar
bertilak
Posts: 10726
Joined: Tue Aug 02, 2011 5:23 pm
Location: East of the Pecos, West of the Mississippi

Re: AA - Capitalized Value of An Investors Social Security

Post by bertilak »

framus wrote: Sat Jun 25, 2022 2:04 pm Despite the angst that is being expressed about Bonds they have served as a reasonable shock absorber. I avoid thinking of bonds as ballast. Ballast will aid in sinking a hull that has been holed.
I've always thought of bonds as ballast -- NEVERMORE! Now I like shock absorber. (Ballast does keep a non-sinking ship on an "even keel.")
May neither drought nor rain nor blizzard disturb the joy juice in your gizzard. -- Squire Omar Barker (aka S.O.B.), the Cowboy Poet
User avatar
gordoni2
Posts: 213
Joined: Wed Aug 15, 2007 12:20 am
Contact:

Re: AA - Capitalized Value of An Investors Social Security

Post by gordoni2 »

It was shown by Merton in 1969 that an investor with constant relative risk aversion should have a fixed asset allocation independent of age and portfolio size.

Where it gets into a little trouble is a precise mathematical solution in the presence of guaranteed income or human capital is unknown. It can however be approximately determined using dynamic programming or reinforcement learning. The effect of guaranteed income will primarily be to offset the risk-free investment asset. As a consequence the ratio of risky to total risk-free assets will be essentially unchanged. However the ratio of the risky to risk-free investable assets will increase as guaranteed income increases.
nisiprius wrote:get the amount of income you need to get from your portfolio of securities, and work from their
There is no way to "work from there" without knowing the risk the investor is willing to bear on their investments, and that depends on how much guaranteed income is also present. A retiree who desires $20k a year from investments can typically take more risk on those investments when their guaranteed income is $100k than if it is $10k.

Thus guaranteed income has to be considered in deciding an asset allocation. The simplest approach is to treat it directly as part of the risk-free total allocation.
framus wrote:How does one determine the capitalized value of one's Social Security?
Treat it as a real SPIA with a money's worth ratio of 100%, and price it out. There are tools on the web for converting a real or nominal SPIA payout stream to a fixed amount (including one that I wrote).
User avatar
ruralavalon
Posts: 26353
Joined: Sat Feb 02, 2008 9:29 am
Location: Illinois

Re: AA - Capitalized Value of An Investors Social Security

Post by ruralavalon »

Capitalizing Social Security is an unnecessary complication in my opinion, and requires several guesses about future events.

Instead to set the desired asset allocation evaluate your ability, willingness and need to take risk in investing.

High Social Security benefits, a substantial pension or annuity can decrease your need to take risk investing, and can increase your ability and willingness to take risk in investing.
"Everything should be as simple as it is, but not simpler." - Albert Einstein | Wiki article link: Bogleheads® investment philosophy
dbr
Posts: 46181
Joined: Sun Mar 04, 2007 8:50 am

Re: AA - Capitalized Value of An Investors Social Security

Post by dbr »

I think Mr. Bogle would say to compute an NPV of the estimated income stream. I think a more realistic approach is to price an equivalent SPIA. Keep in mind that either way the result changes each year you age and with what you use for a discount rate or how prevailing interest rates affect SPIA payouts.

The real dilemma is that capitalizing income streams or not goes back to what method you use to set asset allocation. Mr. Bogle gets there by setting asset allocation using an age in bonds rule and then trying to modify that when there is Social Security. A need/ability/willingness approach to asset allocation most logically enters an income stream as an income stream to affect the evaluation of those three considerations. Other methods of setting asset allocation might be handled some other way still, but I don't have an example in mind.

I don't know what the application is in other contexts, for example how to divide wealth in a divorce.
yog
Posts: 659
Joined: Wed Jan 15, 2020 11:57 am

Re: AA - Capitalized Value of An Investors Social Security

Post by yog »

This really isn't that complicated.

The underlying asset allocation method as mentioned in the video is age in bonds. The capitalization formula is simply Cash Flow / Yield. The risk-free rate is usually the 10yr US Treasury yield. The capitalization of 25k in SS at 3% is 833k, at 4% it is 625k.

Using SPIA rates or Total Bond yield doesn't make any sense to me. US government backed SS demands a lower risk-free yield. This does mean your equity allocation dollars will be higher accordingly. Consider that discounting SS entirely means your remaining portfolio's fixed asset allocation & your lifetime wealth is then heavily overweighted to safe but low-yielding US Treasuries.

Assuming the current 3% yield, a 50yo with a 1MM portfolio targeting 50/50 age in bonds and 25k in future SS benefits puts $916.5K in equities, and an 80yo with $1MM targeting 20/80 with 25k SS puts $366.6K in equities. The numbers dynamically change when your portfolio values are different, your age is different and when current yields are different.

So Bogle was a rules-based dynamic asset allocator...
Post Reply