How Social Security Should Affect Asset Allocation during Retirement

hey everybody welcome back to the financial freedom show my name is rob berger in today's video we're going to cover a topic i've had countless folks email me about and it's simply this how should we factor in guaranteed sources of income in retirement into our overall asset allocation or investment strategy if we're getting a lot of money from social security pensions maybe an annuity should that change how we think about the investments that we have in a 401k or an ira how should we make those two sort of sources of income in retirement sort of work together let me give you an example this email came from a viewer named michael he says enjoying your youtube channel so much could you do a video on how a pension or social security affects asset allocation in retirement and then he goes on does personal capital or portfolio visualize or have a tool to fit those into your mix can you plug in income stream from rental property so those are great questions and here's what we're going to do we're going to look at i think two main approaches that we could take to deal with guaranteed sources of income like social security or a pension or an annuity how those should work with our asset allocation and there are two main approaches we're going to look at those and then i will show you in this case personal capital does have tools i think that can help you model both social security or other sources of guaranteed income as well as rental property income so we'll look at that at the end um so let's get started as i said i think there are two main approaches for dealing with guaranteed sources of income when it comes to how do you do your asset allocation and i call them the asset model and the income model those are just my terms you know if you google them i don't know what you'll find but those are the terms i use and at a high level the asset model says look let's just treat these guaranteed sources of income for kind of what they are they're kind of like bonds right i mean it's a guaranteed source of income it's not volatile you can count on it and so let's just figure out the present value of these future streams of income and just work it into our overall asset allocation just treat it like a bond that's one approach we'll look at that in in a minute the other approach and frankly the approach i prefer the income model says look forget trying to treat them like a bond let's just treat them for what they really are a stream of income and we can take that income and we can subtract it from what we need to live on each year so for example if we need sixty thousand a year to live on just to pick a number and we have twenty thousand dollars in guaranteed income terrific but that still means we need forty grand from our investments and let's now use that number to figure out what our asset allocation can should be with our investments so that we can actually get that much money from those investments throughout retirement so both approaches are doable i don't think there's necessarily a right or wrong way i very much favor the income model as you'll see but i think they're both worse worth covering so let's start with the asset model again the concept is pretty pretty simple figure out what your guaranteed streams of income are again i think for most people would be social security for sure and then maybe a pension uh for you for those of you lucky enough to have one we don't have one and possibly an annuity if you've annuitized some of your portfolio figure out what your say monthly or annual income is and then calculate the present value of that now that may sound complicated it's really not too bad let me show you a couple of resources and as always i'll leave links to all of this below the video so here we go oops there it is so um let me actually begin with this this is an article from michael kitz's i've mentioned him many many times i think he's got a great uh website and this one relates to social security and how to value social security benefits as an asset and he walks through a number of of scenarios and examples and you can see for example we come down here and he's looking look these uh social security benefits can be worth the present value hundreds of thousands of dollars even some approaching a million obviously a lot is going to depend on your your income during your working years whether you're have a spouse or not because then you have you know survival benefits and two folks two people earning potentially social security benefits so a lot of variables and he walks through a lot of those in his article so i highly recommend if this is of interest to you checking out that article again i'll leave a link to it below the video uh but the other resource is this actually comes from a friend of mine todd tressiter owns financial mentor he's got a very straightforward uh what he calls an annuity calculator and it just is really a simple way to determine the present value of a future stream of payments and so it's really easy to use and let me make it a little bigger for you if i can here we go so let's imagine whether it's from social security or annuities or whatever you're going to get we'll call it two thousand dollars a month um and uh now we have to come up with an interest rate and for now i'm just gonna put in five percent but we're gonna come back to that interest rate in a minute and then how long you're gonna you're gonna get you know get this benefit i will say this can get a little tricky because in a way what it's asking you is when you're gonna die and if you're if you're if you've got a spouse when's your spouse gonna die and um yeah i most of us don't know the answer to that um and so there is some guesswork in in calculating this in fact as you'll see there's some guesswork in the interest rate as well but uh for all purposes let's just assume you're going to tire 65 and we'll just assume a 30-year retirement for planning purposes and so we'll plug in 30 and this is annual you could do it monthly for example but we'll do it annually actually no we won't we will do it monthly why because we're doing the payment monthly and if we calculate the present value there it is 300 whoops 372 000 and change now one thing i want to stress this looks like an exact calculation i mean it's down to 23 cents at the end we shouldn't treat it um as precision this is very much um a rough estimate of the present value why well if we go back remember we had to sort of guesstimate on how long we're going to live now changes in this believe it or not might not be as significant as you might think let's just put in 35 and run the calculation you know it went up but it didn't jumps you know in a huge amount 20 grand or so and that's because we're talking about years so far away that the income we're gonna get 30 to 35 years from now it's present value is relatively small but still this assumption does make a difference this interest rate though can make a big difference instead of five percent let's put one percent in look at that we jump from 370 000 roughly to 621 grand this interest rate is makes a huge difference so that raises the question and this is where the asset model approach you know can get a little interesting i guess i'll say we got to come up with an interest rate so what would folks do well you'll often hear reference to the risk-free rate of return and folks tend to look at u.s treasuries for that and they might pick the 10-year treasury i've heard some take the long bond 30-year treasury so what is that rate today well i actually looked it up earlier this morning it was about 1.3 percent for the 10-year um the 30-year believe it or not it's not that much more but if we use that and we'll go back to the calculator put in 1.3 whoops here we go yeah we're still getting a pretty big number and here's the thing as that interest rate rises over time assuming that it does the value of your guaranteed streams of income are going to go down now here again another wrinkle social security goes up with inflation right that's one of the benefits of social security so if inflation gets high and interest rates tend to go up you know you could to some degree get a see a benefit in your social security payments you might with your pension depends on the terms of the pension annuities that are sold today particularly immediate fixed annuities are by and large not indexed for inflation for the most part so there are a lot of different scenarios uh depending on your specific circumstances where calculating the present value is going to be a little bit of some guesswork but again i don't think we need to worry about trying to get this you know to the precision of you know down to the penny that's really not possible i think a rough estimate would be good enough and so the idea here is whatever the numbers are for you whatever your monthly benefit is whatever interest rate you pick i'd probably go with the 10-year treasury uh which is i guess i said about 1.3 right now but you could pick a different number um and then of course how long you think you'll you'll effectively how long you think you'll live and if you have a spouse how long you think your spouse will live you have a rough estimate of the current value of your guaranteed and retirement income payments and so there you go and that you've got a number and you can just simply work that into your asset allocation if you're going to be 60 40 in retirement or 70 30 or whatever your asset allocation is as you're filling up your bonds you would start with uh the present value of your guaranteed or as guaranteed as we can get in life i suppose uh retirement income from these different sources and have your asset allocation and there you go now it seems fairly straightforward once you get the present value of your guaranteed income stream so what's the problem well the problem is whatever income that generates most people are still going to need to pull some amount of income from their investments and i think when you do that you've got to be very sensitive to what the asset allocation is in your investment portfolio so that you have some level of comfort there's no guarantees in life but some level of comfort that whatever income you need to pull from that portfolio the asset allocation will support that over a 20 30 who knows 40 year or even longer retirement and if we take the asset model approach what we're left with in our investment portfolio may or may not be an asset allocation that supports whatever income you need from those investments so i much prefer the income approach and how does that work what's i think pretty straightforward the first thing you have to come up with is how much you need to spend each year in retirement again i guess like a lot of things there's some guesswork in that but i think we all have a rough idea particularly if if we're nearing retirement certainly if we're in retirement so you have some idea of what you need uh to live on in retirement and you can think of that as pre either before tax or after tax a lot of that will depend on how much of your portfolio is in a roth uh account versus traditional retirement accounts versus taxable accounts but um whatever approach you take um yeah you know and that's not an important unimportant question i just don't think it'll be the same for everyone but you'll have your annual spending we'll assume it's before taxes so you have what you need and then you subtract the guaranteed income that you have from annuities uh from pensions and from social security and again the tax treatment on all of those can be different for different people and different situations so you'll need to figure out the tax ramifications for your specific circumstance but you'll simply take the income that you need you'll subtract the guaranteed sources of income that you have and what's left is what you need from your investments right and i think once you have that number you can then figure out your asset allocation and here's the way i would think about that i would start with uh bill bengan and if long time viewers know who that is if you don't no worries i'll show you um here he is there he is in black and white there's mr bengan he published a paper in 1994 called determining withdrawal rates using historical data it was a pretty um revolutionary concept at the time but basically what he was trying to figure out was for a 30-year you know traditional retirement how much can you take out in year one what percentage of your investments can you take out in year one and then adjust that number uh each year for inflation uh and have the money your investments last at least 30 years right that was what he was trying to figure out and in doing so he looked at a number of different asset allocations let me show you and again i'll leave a link to this paper below the video let me just give you this chart as a starter what he looked at he said what if we have 50 in stocks and he used the s p 500 and the rest in intermediate term treasuries and we took out three percent in the first year of retirement and whatever that number was it's if you have a million dollar portfolio it'd be 30 grand whatever that number was we'll adjust it each year in retirement uh by the cpi by inflation how long based on historical data and he went back as you can see here to 1926 how long you know would your investments last and he looked at it up to 50 years he stopped at year 50 but he looked at it up to 50 years and you can see didn't matter whether you started in 1926 just before the stock market crash of 29 in the great depression didn't matter if you've retired right before world war ii or in the middle of world war ii or before the stagflation of the 70s and early 80s that if you're old enough like i am you remember it didn't matter with a starting withdrawal percentage of three percent and a 50 50 asset allocation every retiree that retired in these time periods uh their money lasted a full 50 years it's pretty comforting now he looked at other starting withdrawal rates here's four percent you notice some of these bars in the bar chart don't quite make it to 50 years but they all make it to at least 30 and that's how we end up with the 4 rule but what i want to show you for our purposes is this chart it's on page five here we go he looked at different withdrawal rates you can see here's one percent all the way up to eight percent and he looked at different um stock allocations this first bar within each group is the zero percent stocks meaning it's 100 bonds and then the all black bar was 25 stocks 75 percent bonds it went all the way up to 100 stocks and and it's interesting um at four percent right which we get the four percent rule you'll notice that in all bond portfolio this left most left bar here hope you can see that right there i'll make this maybe make this a little bigger for you oops here we go it's this bar right here really didn't even make it to 20 years you see this line here is 20 years so 100 bonds really really fails quick and even the 25 stock 75 percent bonds i mean it did a little better but didn't it didn't make it to 30 years the two best you can see them right here are 50 50 50 stocks 50 bonds and 75 stocks 25 bonds and he concluded from that that most uh retirees really should have if you're gonna use the four percent rule uh and by the way i'm going to i'm going to turn this back to annuities and social security and pensions it all relates you want somewhere between 50 and 75 stocks and what he actually said was if you can handle the volatility try to get as close to 75 in stocks as you can that's really the the best outcome when factoring in not only making sure your money lasts at least 30 years but also keeping an eye on what your portfolio grows to as well because a lot of us want to leave money to family and to charities so he said you know keep it between 50 and 75 in stocks and really as close to 75 as you know you're comfortable with and i've read a lot of papers since this 1994 paper and they all pretty much i'm not aware of any any paper really there are a couple that suggest 100 stocks would be okay but by and large uh they tend to to confirm what bill binkin um found now so where does that how does that relate to the income model that i've talked about well it seems to me that if you're going to need after you've factored in your guaranteed income if you're still going to need to draw about four percent from your your investments in year one and then adjust that for inflation going forward you really need a stock allocation roughly somewhere between 50 and 75 percent at least that's what bill bingen concluded and it seems reasonable to me based on everything that i have read so that's where the asset model could get you in trouble because if if the asset model if you treat all of that as bonds the present value of all these guaranteed incomes is you treat them as bonds and and factor that into your overall asset allocation if that ends up creating an investment portfolio for you that doesn't fall within the 50 to 75 percent in stocks at least according to bill bengan's research that could cause you some problems at a minimum i think you want to be aware if you're going to follow the asset model what your asset allocation is just from your investments and does it fall within that 50 to 75 percent range particularly if you're gonna pull out roughly four percent or perhaps a little more from your portfolio in year one of retirement uh and then adjust it for inflation now some of you are saying well rob that's great appreciate all that work and those studies and links and great but look after i factor in guaranteed income i only need like one or two percent uh from my investment portfolio in fact maybe there are years if i had to i don't have to take anything out you know if things got really bad in the market and you know life was crazy i could just live on my guaranteed income well that's terrific and that gives you a lot of flexibility in fact if we go back to bingin's paper we can see we'll take the two percent which is a second group of bars right here if you only need two percent of your investments in year one after you factor in guaranteed income well goodness i mean you could just have about any asset allocation you wanted i mean uh if you if we exclude the zero percent stock allocation for a minute all other all of the other allocations from 25 percent stocks all the way up to 100 stocks at a two percent initial withdrawal rate lasted 50 years and even the 100 stocks i mean excuse me 100 bonds this bar on the left lasted what would you call that 30 to 35 years and if you were fortunate enough to only need one percent in year one then all of the allocations lasted 50 years i mean you know you've got all kinds of of choices and here is why i like the income model it forces you to look at how much you're going to need to rely on your investments if it's near four percent in year one and then adjusted for inflation going forward you say okay i gotta take a fair amount of money out of these that my my investments let me think about what that asset allocation is going to be it's great that i have all this guaranteed income over here from social security or whatever but even with that still got to get my four percent out of my my portfolio in year one and then adjust it for inflation i better really be mindful of the asset allocation so that i can generate that four percent adjusted for inflation going forward without running out of money probably somewhere in the 50 to 75 percent in stocks is probably what i'm going to need on the other hand if you do this analysis and you only need one or two percent for example in the first year of retirement then you've got all kinds of choices and i think there are a number of reasonable options you could say you know i can take the risk i'm going to go 100 stocks or maybe something greater than 75 percent stocks whatever it is for you because i've got this guaranteed income that i can always fall back on and i don't need a lot out of my investments and it gives me maybe the best opportunity to grow in wealth that i can leave to family that i can leave to charities and that's important to you at the same time others may say look i don't need to pull a lot from my investments i'm going to take the opposite approach i kind of sleep better at night knowing that i'm only whatever 75 percent bonds and only 25 stocks but that's okay because i'm likely to be all right again there are no guarantees and even bill bingham as great as his paper is it ain't gospel so just keep that in mind but still uh i can sleep a little better knowing that my portfolio is a little less volatile and that should be okay because i only need maybe one or two percent uh in the first year of retirement adjusting that for inflation so i think you could use uh this information to reach two different i think reasonable asset allocations based on your personal goals and your risk tolerance and a number of other factors so that's why i like the income model more than the asset model there's a reality to pulling out money from your portfolio and you need to evaluate that portfolio standing on its own to make sure the asset allocation will support the withdrawals that you need if you're going to go with the asset model i think at a minimum you need to be look mindful of what your asset allocation is in your portfolio standing alone and ask will this support based on the best data we have will this support uh the money i need to take out of my investments throughout retirement hope that makes sense uh that's my take on it as i said i prefer the income model but you could you could make either one work i think now let's get to the final question that's personal capital so let me show you this and i'll go to overview and show you on my screen so this is a demo account you may recall i've had a whole bunch of different portfolios in here before i've actually deleted all of them but three the specific portfolios aren't important for our purposes uh the total dollar amount is again this is all made up but it's just over three million and here's what you do you go to planning and you go to retirement planner now what i've done is i've set my current age at 67 and for the record i may look 67 but i ain't okay um and i'm going to retire at 67. that's what i've set it up for you can do set all of this on your own you can go here to edit profile and you can you know your your status um your file text status your birthday you can add children but i just try to make it simple and i've set my social security to zero dollars for a moment right and i've set my spending to 120 000 a year starting right now and i did that because remember we've got about three million dollars in the portfolio and that's four percent uh and so there you go um and there are assumptions that you can edit effective tax rate the inflation rate the three and a half percent my life expectancy is at 92. uh uh let's change this uh we'll bump it up to 95. we'll get crazy all right this uses monte carlo simulation we saw it spin through and look at 5000 scenarios so this is this is important this is fundamentally different than what bill bengan did bill bengan looked at actual historical data what did the stock market do from 1926 all the way through what did the bond market do what was the actual inflation rate a lot of tools today use monte carlo simulation you have to have some inputs into the tool which personal capital i think more or less takes care of uh but what it does it just simulates in this case as you saw five thousand different scenarios it's not that one is right or wrong good or bad they both serve different purposes one of the benefits of monte carlo is it's going to consider scenarios that haven't happened since 1926 so so because they haven't happened they weren't included in bill bingan's analysis on the other hand the benefit of bill bingen's analysis is it was actual history and while history doesn't repeat itself how's it go sometimes it seems to rhyme i mean so you could have scenarios in a monte carlo simulation that are so extreme they're almost unlikely to ever happen but i suppose anything's possible the point is i don't think one is better or they're just different but i pointed out that this uses monte carlo simulation i would say most retirement calculators probably do and so you're going to get a percentage what's the likelihood that you'll not run out of money and they'll do it as a percentage they'll look at 5000 scenarios you know for stocks for bonds for inflation and then how many of those scenarios did you succeed did you did your money last in this case until 95 and how many did you did you you know run out of money early and it just calculates a percentage effectively and gives you a score so let's look at it so here you can see they gave me a score of 76. they kind of prefer 85. so in this case you know it's kind of calling it close by the way if i edit the assumptions and i say i'm going to live to be 92 what's it do yeah it bumped it up to 85 85 and they call that good shape a result between 80 and 90 percent means you're in good shape so that's what they're aiming for right now if we go back and we put the assumption back to 95 well those three extra years are going to kill me see what i did there all right anyway um you know i'm at 76. i'm four percent below what what i want to be to be in good shape according to personal capital so um but i haven't factored in social security right so let's put that in now they have they can you can sync an estimate it's based on other data within um uh personal capital what i recommend is just go to the social security administration figure out what your benefits are going to be um you can also just put whatever you want in here right i could just not sync it and say okay um it's gonna be 20 000 bucks a year save that and it's going to recalculate my plan you can see it's now bumped it up to 90 percent right so now i point this out because this is not really in some ways it's not an asset model or an income model but it is factoring in what we've saved so far right because you would connect your own obviously your own investment accounts here so it would factor in what you've saved whatever the reality is for your social security you could add a spouse as you saw you could add children not that would have a direct impact i don't think but certainly a spouse will you can change your spending you can add one-time event you're going to buy a vehicle in a couple of years or you're going to renovate the house when you retire or take an around-the-world trip the other thing you can do is model income events so michael in his question mentioned rental income well sure we can do a rental income we can say okay i'm going to get i don't know 10 000 a year we'll call it before taxes you can adjust it for inflation or not you can you can either set it for every year or just a set number of years and also when it'll start right so you can model that um as well of course that's only going to improve my chances of you know i guess dying before i run out of money to 94 so this tool particularly for a free tool i think is probably the most robust one of the most robust retirement calculators you can model a lot of different things and so in response to michael's question i wanted to show you that again it's not really an asset model maybe it's more of an income model but i think even if you use a tool like that it's still important to know what your asset allocation in your investment portfolio and what percentage you know are you gonna take from that in year one and presumably adjust it to some degree by inflation every year and then think through okay if it's near four percent am i somewhere between the 50 to 75 percent in stocks if i'm not why why maybe why not there might be good reasons um but you want to at least understand those issues and think them through so there you go that's my take i think it's an important question a very important question and you know a lot of this is based on some assumptions and some i'll call it guess work i think we can make educated guesses and we may have to change our analysis over time i think both the asset model as i called and the income model could work i much prefer the income model but i also think it's pretty smart to put this information whether it's in personal capital or some other retirement tool into a retirement tool see what they have to say about your plan again don't take it as gospel but i think it could give you some insights that you might not otherwise have so there you go that's my take michael thanks for emailing me a great question if you have any questions or comments leave them below the video do my best to help you out any way i can and until next time remember the best thing money can buy is financial freedom

Channel: Rob Berger

Views: 30,376

Keywords: social security, retirement planning, social security retirement benefits, retirement income planning, social security retirement, retirement income, annuities, pensions, asset allocation

Id: NhmbwgxmK14

Length: 29min 47sec (1787 seconds)

Published: Tue Sep 07 2021