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 don’t think you have to have a value for SS to decide how much you want in bonds at all. That’s the whole argument in this post.
When you annuitize, you’ve converted a liquid asset into a personal pension, removing market risk — and control. Social Security is basically the world’s best annuity with a COA. You don’t hold an investment; you hold a contractual promise. That’s a different asset class entirely: it belongs on the income side of your retirement cash flow, not in your portfolio allocation.
If you treat guaranteed income as part of your bond allocation, you might be tempted to overweight equities to “balance” it — e.g., 90/10 because you think Social Security is the missing 40%. That’s dangerous because:
You can’t rebalance the SPIA or pension if equities crash.
It doesn’t absorb volatility — it simply sits outside it.
You could end up taking more market risk than your true ability warrants.
By contrast, if you treat these income streams as reducing your need for withdrawals, you correctly model the outcome they affect — spending, not allocation.
I see many of the objections to Jim’s post as assuming this is some kind of value judgment rather than advice on the heuristics of portfolio construction.
When you annuitize, you’ve converted a liquid asset into a personal pension, removing market risk — and control. Social Security is basically the world’s best annuity with a COA. You don’t hold an investment; you hold a contractual promise. That’s a different asset class entirely: it belongs on the income side of your retirement cash flow, not in your portfolio allocation.
If you treat guaranteed income as part of your bond allocation, you might be tempted to overweight equities to “balance” it — e.g., 90/10 because you think Social Security is the missing 40%. That’s dangerous because:
You can’t rebalance the SPIA or pension if equities crash.
It doesn’t absorb volatility — it simply sits outside it.
You could end up taking more market risk than your true ability warrants.
By contrast, if you treat these income streams as reducing your need for withdrawals, you correctly model the outcome they affect — spending, not allocation.
I see many of the objections to Jim’s post as assuming this is some kind of value judgment rather than advice on the heuristics of portfolio construction.
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.
Can’t recall my exact intended post, but this wasn’t it! Glitch in my posting or laptop, not WCI’s. Anyway PharmMedMD’s earlier post- as my post here copies exactly- reminds me if I want to estimate the ‘value’ of a pension or SS, don’t pretend that is in hte portfolio so one can convert it into stocks to balance!!! WCI’s most important contribution to my handling of my several annuities (pensions rather) is: they lower the amount I need for ‘save 25 x your needed income at a minimum’ planning for a 4% SWR.
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
That’s part of the argument. The rest is that they go away instantly if you die. They’re also challenging to value. And often at least somewhat illiquid/non-fungible. It’s just not practical. So don’t bother trying to value them. Just subtract that income from what you need and use your portfolio for the rest. But if a 75/25 portfolio is right for you, it’s probably right for you whether you get $1500 a month in SS or $2500 a month in SS.
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 don’t include it in my retirement portfolio. Nor my net worth, although I guess I could do that.
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)
I think you’re understanding exactly what I’m saying.
WCI, I believe I’ve seen it stated on this very blog that “money is fungible”.
If you can turn a given amount of money in your portfolio into a SPIA… and presumably sell a guaranteed income stream to another investor for a lump sum… doesn’t this imply that your SPIA is in fact effectively a valid component of your portfolio? It is fungible with other elements of the portfolio.
It seems to be mental gymnastics to suggest that selling $100,000 of stocks and buying a $100,000 SPIA for its future income somehow diminishes your portfolio by $100,000.
Pensions, social security, and SPIAs provide a return just as a bond’s interest payment or stock dividend payment provides returns. I fail to see why one is part of your “portfolio” but another isn’t.
In addition, the presence of these guaranteed income streams allows you to adjust the stock risk you can take in the rest of the portfolio.
A person with no pension, no social security, and no SPIA needs a greater percentage of their portfolio in bonds compared to a person whose spending is 100% matched by these guaranteed income streams or do you disagree?
If you agree, then this implies that these belong in the “portfolio” for asset allocation considerations.
You don’t think if you take $100,000 out of your portfolio and buy something with it that the portfolio has decreased in value by $100,000? Seems a tough argument to make.
Look, I don’t care where you put it in your portfolio. But as far as portfolio management goes, you will find it is FAR easier to ignore those income streams when setting asset allocation, rebalancing etc.
I also don’t disagree that having income streams like pensions, SPIAs, and SS reduces your need to own bonds. But they’re still not bonds. But I think I’ve said that in the original article as well as half a dozen comments already.
If someone bought a SPIA with a Return of Premium feature, I think an argument could be made for including the unrecovered amount of their initial lump sum premium expense in their Net Worth until they had received monthly SPIA payments that added up to their initial investment in the contract.
If someone did that, I suppose they could include that figure in their Bond allocation. Every month that line item on their Net Worth Statement would decrease by the amount of the monthly SPIA premium payment they got until the insurance company no longer was on the hook to give back to their beneficiary any of the initial premium payment.
While such an accounting exercise might be technically accurate, I don’t know that it would be particularly helpful. But some folks might prefer to handle it that way.
Seems like a lot of hassle, but one can do whatever they want. There is no internet net worth police that I’m aware of.
Ritch, your scenario is EXACTLY my situation:
I converted the cash value of my whole life insurance policy (piece of trash !), via a 1035 exchange into a SPIA.
It is a 10 year “Certain” policy, so me or my heirs will get all of the funds in the SPIA – unless the insurance company goes bankrupt.
The funds are directly deposited into my bank account monthly. What hassle is it to decrease the remaining value of the SPIA once a month ?
As the initial annuity value is/was just over 1M, you can be damn sure that I include the remaining value of the annuity in my net worth. Moreover, when it was purchased, as it represents bonds/cash, I adjusted the remainder of my portfolio accordingly to keep my equities at my desired level. Big disagree WCI !
You describe a SPIA as having a value that should be decreased with each payment (because that lowers the remaining amount that you might collect as the Return of Principal Guarantee) but that dramatically undervalues the income stream you are receiving (which in most cases greatly exceeds the guaranteed ROP) while also distorting your ease of access to the remaining principal you have not received. In most scenarios you have to die to get the remaining the ROP, which I would consider a dramatic constraint for any financial calculation, but for other fixed income products you handle as portfolio assets (e.g. bonds) you can sell them at any time for whatever the market offers. This is not a debate about whether or not a SPIA is good or bad (it can be much more important and useful than stocks or bonds for many scenarios), but whether you can handle it using the same tools we apply to portfolio assets which allow us to rebalance, leverage, sell or transfer in ways that you cannot do with a SPIA.
1) I do not have to die to get all of the ROP – it is 10 years PERIOD CERTAIN – me or my heirs will get ALL of the principal and interest back.
2) as I note below: I have significant other assets such that “reallocating during a market crash” or having sufficient liquidity, will not be an issue. Having that monthly payment regardless of the market crashing 50% will not hurt my falling asleep at night 😜
The problem with counting the unreturned portion of the premium for a SPIA with a guaranteed return of premium (ROP) is that you do not have control over the time period for the ROP. In this way it differs from a bond and so should not be used in portfolio asset calculations the way you would handle a bond (which might be quickly harvested to reallocate to equities during a market crash). That lack of control over time makes it impossible to use it in portfolio rebalancing scenarios when stocks fall or stress calculations during volatility. This is not a criticism of the guaranteed income stream –which is much better than a portfolio asset during extremes of volatility– but is a warning that our tools for adjusting a portfolio do not apply to income streams outside the portfolio which is why we don’t consider the SPIA that way.
Re : The problem with counting the unreturned portion of the premium for a SPIA with a guaranteed return of premium (ROP) is that you do not have control over the time period for the ROP.
1) as I mentioned, my SPIA is for 10 years, and,
2). I have significant other assets such that “reallocating during a market crash” is not an issue.
I am not trying to make the point that the SPIA is not a good choice for you or that it isn’t useful. I am stating that you cannot count it as a portfolio asset because your access to the balance (even with the 10 year certain period you do not have control) is not the same as for a bond you can sell. The fact that you don’t need to reallocate during a crash does not change whether or not you should consider it as a portfolio asset; it has left your portfolio and is now a guaranteed income stream instead.
Surprisingly strong reaction to this post in the comments.
Maybe that’s a sign that people are attaching their self-confidence and/or their own opinion of themselves a little too much to their net worth or other financial numbers that it feels so threatening to have anyone tell them they’re worth less than they would prefer to be. I mean, if a new radiologist who actually has a negative net worth added in $16 million (for the value of her future earnings) the day she walked out of residency, that might feel pretty good.
Net Worth is not what you’re really worth as a person. It’s just a financial number and it isn’t even a very useful financial number. The total of your investable assets/portfolio/asset allocation, however, is a useful number for a few calculations, but mostly you just need an easy way to get it so you can do your portfolio chores like rebalancing and deciding where your next investment dollars go etc.
I don”t like the way the term “Net Worth” is defined. I greatly prefer the term “Net Wealth” when talking about financial assets.
In my view, my net worth is best quantified by what I give away, how I make the world a better place, how I serve others.
Yes, we have a lot of net wealth. Every day I will challenge myself to use our net wealth as one of many tools to increase my net worth in this world by giving back.
Excellent points. I like that term, Net Wealth. But we’ve got to convince the rest of the world to use it before we should start using it routinely.
Absolutely. The point of this post is not to judge anyone in any way, shape, or form. If anything, I’d make the point that you shouldn’t focus too much on your net worth anyway. It is not a value judgment of any kind either. Nor am I telling you not to take Social Security or not to buy a SPIA or not to pay off your house or work at a job that offers a pension or any of that. What I’m saying is when you go to add up all of your investments and put them on a spreadsheet so you can manage your portfolio, leave all that stuff off the spreadsheet and you’ll be glad you did. That’s it. I would have put something like that in the post if I had anticipated this reaction to it, but I certainly didn’t. I thought this was just a humdrum blog post I could link to every time I get this question in my email box (which is a lot.)