By Dr. Jim Dahle, WCI FounderI run into a lot of Do It Yourself (DIY) investors who are trying to figure out how Social Security, a pension, a Single Premium Immediate Annuity (SPIA), or their home equity fits into their portfolio. Newsflash! It doesn't. None of it.
There are some things that are included in your net worth but not your portfolio. There are some things that don't go into either. Your portfolio is your investable assets. It has an asset allocation. That asset allocation can and should change based on your need, ability, and desire to take risk. Investing is about risk control more than anything else.
Things That Go into Your Net Worth But Not Your Portfolio
Your net worth is everything you own minus everything you owe. It is the measurement of wealth. It includes all of your assets and all of your liabilities. It includes your portfolio, whether in taxable or in tax-protected accounts of some kind. It includes your home and any mortgage on that home. It includes your cars, jewelry, and other possessions (although I suspect many of us ignore that stuff because it's a pain to try to value it). It certainly includes auto loans, credit cards, investment-related debts, HELOCs, and other debts.
Things That Don't Go into Either
But you know what doesn't go into your net worth, much less your portfolio?
- Your job
- Your spouse's job
- Any pensions you have
- Social Security
- Any SPIAs you've purchased
These are all sources of income, but they are not assets in your portfolio. Now, I agree that it is possible to sell some of these sources of income, just like you might sell your home. If you sell your home, start renting, and put the proceeds from the sale into your portfolio, fine, count it. If you sell your pension or SPIA and put the proceeds into your portfolio, you can go ahead and count that, too. But don't sit around trying to put some sort of value on your Social Security and count that in your portfolio.
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Reducing the Need for Income
These non-portfolio assets and income sources often reduce your need for income from your portfolio. For example, if you need $120,000 to live on and you have a pension that pays $20,000, Social Security that pays $35,000, and a SPIA that pays $12,000, well, now you only need your portfolio to provide $53,000 a year instead of $120,000. That's awesome, and (using reverse engineering of the 4% rule) it suggests you could retire on $1.33 million instead of $3 million. But that doesn't mean you should somehow call the pension $500,000 worth of bonds and Social Security $875,000 worth of bonds or something silly like that. That's not the way it works.
Even some of your assets reduce the need for income. If you own your home, you save rental payments on a similar home. Less income needed. Same with your car compared to renting one. But you still shouldn't put these consumption items into your portfolio. Investment properties, yes; homes you live in, no.
Why Do People Do This?
I think people do this for three reasons. First, they often buy these sorts of things with money that came out of a portfolio. A SPIA is a perfect example. Sorry, though, you spent that money on an income stream. It's gone. It's no longer in your portfolio.
The second reason I think people do this is because it makes them feel richer. Who wants to be a millionaire when they can be a multi-millionaire by including some value for their Social Security into their net worth statement? But that's just as dumb as 22-year-olds including all of the value of their future earnings in their net worth.
The third reason people do this is because they saw someone else try to do it and assumed that it was a smart thing to do. It isn't. So, don't.
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If You Can't Resist
If you must do this for some reason, know that it's your money, your life, and your decision. Do whatever you want. Investing is a single-player game. It's you against your goals. I really don't care what rules you play by. I just don't think it makes any sense to try to stick consumption items and income streams into your asset allocation.
What do you think? Do you include any of this stuff in your asset allocation? Why or why not?
I choose to include SS, pensions etc. bc I consider my portfolio to be future consumption. It’s why I saved in the first place. By focusing on total future consumption I don’t get hung up on current valuation swings (eg I have a TIPS ladder that lost a lot of value when interest rates rose but I don’t care because it will pay out as planned regardless of today’s rates). More importantly those future streams affect my asset allocation today bc I can be more aggressive than if I didn’t have them.
I agree you can and should change your asset allocation because you have some income streams. That changes your need desire, and ability to take risk. But that doesn’t mean you should include them. It’s not practical. Imagine you’re 92 years old and have a SS benefit of $2,000 a month. What’s that worth? What’s it worth next month when you’re in the ICU? What’s it worth the month after that when you go home doing well? Too impractical to value and fix some sort of “bond value” to it. Best to leave it out when rebalancing your portfolio and doing other portfolio chores.
Wrong, wrong, 100 times wrong. As long as Soc. Sec. remains solvent ( or partially solvent) that annuitant payment is entirely as valuable as “Xdollars earning 4%”……for most docs who pay maximum FICA taxes and “earn” a $50,000/year Soc Sec annuity, that fully equals a $1,250,000 “pot”…..now, you cannot sell it or leave it to anyone, so yes it is not an exchangeable asset. However, without it one would in fact need another $1,250,000 “pot” of your own ( depending on how long you live). Ditto for a pension: same points plus many pensions provide a residual annuity ( albeit at 50%) for a surviving spouse.
Your basic points are accurate regarding a strict definition of assets and portfolios and net worth. It is the, for lack of a better term, “slant “ of the article that irritates. You don’t state it directly but you seem to “undervalue” Soc Sec and Pension income.
I think you provide an immensely valuable service with the WCI…. sort of Suzie Orman for rich docs ( and we are all rich by any reasonable standard). Ok, maybe a bit of Larry Summers and Steve Rattner layered on top. You emphasize economic literacy and careful priority setting within the context of values that we and our partners/spouses clearly articulate and continue to evaluate as we move along. Good things, each. You do not, perhaps, “allow for” folks who have little interest in “early retirement “ as a substantial life goal. I love “live like a resident “ and don’t fall into the trap of trying to live like society’s expectations for our physician lifestyles. Maybe consider this: “plan for and structure your financial life as if you shall retire by age 55 or so”…. Then do with that whatever works best for you and your loved ones when you reach that age. It will provide options for docs and the added benefit of learning how to be “happy” with much more modest income and lifestyle…. while feeling and being quite financially “secure”.
Also, occasionally consider those of us who still love practicing medicine, may functionally never fully retire and value the purposefulness of our profession very highly…. For many of us an issue that we face is acknowledging that our deferral of full retirement is costing us real bucks ( this is in reference to those of us who have, for instance, FERS pensions….).
Thanks
I read most of your newsletters but sometimes I think you could look beyond your own very unique circumstances and values a bit more.
Thanks for the feedback, but maybe best to stay focused on the topic at hand in your comments on that post and send the negative feedback about tone or the blog or the business or whatever by email.
I agree your SS reduces your need to take risk/need for assets etc. But sticking it in your portfolio asset allocation is a bad idea for portfolio management practicality. Yes, you can try to value it like any other income stream. But that valuation is not terribly accurate for the purposes you want to value it for.
I do basically agree with you, but knowing what your Social Security is worth is important to help you decide how much money to put into bonds. Also, the value of your home is important so that you know if your heirs will owe inheritance taxes.
I understand net worth and portfolio as you define it. Now and then in envy of the many better paid docs (I was FP and ‘never’ private practice) speaking of 8 figure net worth I calculate our supposed NW if our pensions were funds paying out some percent. (Haven’t bothered factoring in SS, don’t trust it’ll truly be there.) However as I often note over half the pension income is gone if I’m widowed, a smaller portion if my partner is. So it isn’t NW that we can adjust or leave to our heirs, it’s just as WCI helped me comprehend a few years back and as you explain here a reducer of the size of NW and its return needed to provide for our needs in retirement. And must be counted even for that 3 ways- to also cover either of us if we’re widowed.
So forgive my wanting to congratulate myself for trading high salary for a sizable inflation adjusted pension. It’s of more comfort at times than knowing we’ve served our country. And I am finally realizing I already had a few large deferred annuities whilst agreeing with your articles that buying annuities is seldom a better plan than investing a whole bunch of money.
I think the point is we shouldn’t be congratulating ourselves about our net worth anyway. I’m not saying it’s a bad move to take a chunk of your portfolio and buy an income stream with it. Or to take a job that gives you an income stream later or anything like that. I’m saying when you go to make your spreadsheet with your asset allocation and its various components, leave the pension and SS off it. That’s it.
Really, But I always though that the Social Security and pensions would be part of my net worth if not my portfolio as I am not actively managing it to the best of my abilities. Ever since I have started on my FIRE journey, I have been considering them to be part of my retirement corpus as they have been modestly growing at 4% CAGR. Glad to come across your POV. Maybe I will consider my optics for the future retirement.
Count them as “retirement corpus” (whatever that means). But don’t count them as net worth or investable assets. It’s not practical. Obviously they’re going to help you pay for retirement, but don’t try to assign them a value and reduce your bonds the exact same amount or anything like that.
Is the argument basically that if you can’t rebalance it, it’s not part of your portfolio? That’s certainly true of annuities. But you can always reprice your SPIA at fair market value based on current ages. While you can’t reduce investment in SPIAS you can certainly buy more. It ratchets up only in one direction however. So an investor using SPIAS as the fixed income portion of the portfolio (to get mortality credits) may reprice every few years to account for inflation and interest rates and aging. That seems awfully close to viewing them as an investment.
I do agree that for SWR purposes I’d just use SPIA income to reduce my required withdrawals.
I also seem to recall Bogle suggested that one consider SS as a fixed income asset when considering the aggressiveness of the asset allocation.
Just some thoughts typed on my phone waiting in a long line. Thanks
Where do you think a DAF belongs? On the one hand, the money is no longer “mine.” On the other hand, I have almost complete discretion how to invest and donate it. My DAF constitutes ~20% of my net worth, and I actually donate more from it annually than I spend on myself from my true assets.
Perhaps related to your previous “Life Got Really Expensive” post, I didn’t see tithing. Do you do this once a year into your DAF, and then not track regular donations from it?
I love the Spice and Vinegar that Jim brings to this post. As opposed to the Cotton Candy posts that may not push us on our ways of thinking
Thank you for this article. It reminds me to think of SS as more of a way not to drain my portfolio, as opposed to being something I manage, or control. I think of a pension or SS as a negative expense — an offset to, or credit toward my expenses. If my expenses are greater, then my portfolio is reduced. If my expenses are negative, then I add to my portfolio. My portfolio are my reserves.
Dictionary definitions, consistent with your article.
* portfolio – a range of investments held by a person or organization. the securities held by an investor : the commercial paper held by a financial house (such as a bank)