AA - Capitalized Value of An Investors Social Security
AA - Capitalized Value of An Investors Social Security
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
https://youtu.be/BAqlll-vMjQ
How does one determine the capitalized value of one's Social Security?
-Framus
Re: AA - Capitalized Value of An Investors Social Security
Because real interest rates are about zero, you can simply multiply your yearly benefit by your remaining life expectancy.
- nisiprius
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Re: AA - Capitalized Value of An Investors Social Security
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.
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.
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Re: AA - Capitalized Value of An Investors Social Security
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!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.
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
Re: AA - Capitalized Value of An Investors Social Security
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.
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.
Re: AA - Capitalized Value of An Investors Social Security
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.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.
Before capitalizing income streams one needs to ask how one is arriving at asset allocation in the first place.
Re: AA - Capitalized Value of An Investors Social Security
Thanks. The Bogle capitalization of one's income stream was not something I'd seen mentioned previously.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.
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.
Re: AA - Capitalized Value of An Investors Social Security
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.
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Re: AA - Capitalized Value of An Investors Social Security
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
Re: AA - Capitalized Value of An Investors Social Security
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.
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.
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.
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.nisiprius wrote:get the amount of income you need to get from your portfolio of securities, and work from their
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.
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).framus wrote:How does one determine the capitalized value of one's Social Security?
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Re: AA - Capitalized Value of An Investors Social Security
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.
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
Re: AA - Capitalized Value of An Investors Social Security
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.
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.
Re: AA - Capitalized Value of An Investors Social Security
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...
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...