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Social Security and Asset Allocation

Consider two investors, Allan and Bob. They both retire at age 62. They’re both unmarried. They each have $40,000 of annual expenses and a portfolio of $650,000. And, if they claim Social Security at their full retirement age of 66, they’d each receive an annual benefit of $20,000.

The only difference between the two is that Allan decides to claim Social Security ASAP at age 62, while Bob decides to wait all the way until age 70. As a result:

  • Allan will be receiving $15,000 of Social Security per year (starting at age 62), and
  • Bob will be receiving $26,400 of Social Security per year (starting at age 70).

How should this difference affect the choice of asset allocation for their portfolios?

Stocking up on Cash (or CDs, or Short-Term Bonds)

Allan will have to satisfy $25,000 of (inflation-adjusted) expenses each year from age 62 onward, because he’s getting $15,000 of Social Security per year. In contrast, Bob will have to satisfy $40,000 of expenses for 8 years (because he isn’t yet receiving any Social Security), then just $13,600 per year for the remainder of his life.

Because Bob is going to be spending down his portfolio at a fairly rapid rate during those first 8 years, I think it makes sense for Bob to have a significant amount of holdings that can be relied upon not to experience large losses during those 8 years.

If I were in Bob’s situation, I’d want enough super-safe holdings to satisfy the additional (temporary) shortfall that comes from holding off on claiming benefits. For example, I might create a CD (or bond) ladder with a $26,400 CD maturing each year for 8 years.

What’s the Point of Having Extra Safe Assets?

One of the challenges of delaying Social Security until 70 is seeing your portfolio decline dramatically in the pre-Social-Security retirement years.

By designating specific assets for the extra spending during those years, you can make it mentally easier on yourself. You’ll know ahead of time that the plan is for those assets to be spent, so it’s not scary when you see that that’s exactly what’s happening. (In addition, it makes it easier to assess how well the rest of your portfolio — the part that’s intended to rest for the rest of your life — is doing.)

What to Do with the Rest of the Portfolio?

The remainder of Bob’s portfolio — so, somewhere in the range of $438,800 (i.e., $650,000 minus 8 x $26,400) — should probably look roughly the same as Allan’s portfolio. In each case, the point of the portfolio is to satisfy a relatively steady level of spending, starting at age 62 and lasting for the remainder of the investor’s life.

In other words, this money can be invested in keeping with the conventional wisdom for a retirement portfolio: build a diversified portfolio with some sort of middle-of-the-road asset allocation, using low-cost mutual funds or ETFs.

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  1. Mike,
    I am surprised you didnt mention something w/ regard to annuities in the strategy you outlined. 🙂
    Happy trails, Mike

  2. Mike,

    Good point. Depending on the investor’s preferences, an inflation-adjusted lifetime annuity could make sense for part of the long-term portfolio.

    For example, Bob might want to purchase such an annuity to satisfy all or part of the $13,600 per year that he’ll need his portfolio to provide for the rest of his life. That said, with a long-term portfolio of ~$438,800 and annual expenses of $13,600, he’s looking at a withdrawal rate of just over 3%, so an annuity is probably not needed.

    Or, in other words, delaying Social Security is akin to buying an annuity. But some investors might want to further annuitize by buying an actual annuity.

  3. You lost me. Allen and Bob both have expenses of $40,000 annually and equal portfolio values ($650,000). At age 70, Allen will have $450,000 (650K – 8*25K) and Bob will have $330,000 (650K – 8*40K). At that point, Allen will still be forking out $25K per year but Bob will be forking out only $13,600 per year. When both are 80 years old, Allen will have $200,000 and Bob will have $194,000.

    Like I said, you lost me. What’s your point? Also, the e-mail that links to this web page has different figures than what the web page has.

    Please clarify.

  4. Jeff,

    The email had a mistake. I apologize for any confusion that caused. The figures in the article on this page are the ones I intended.

    Other than that, I’m not certain I understand what you’re asking. Are you asking about why Bob would have wanted to delay Social Security? (That was not the point of this article, which is why I did not address it. But it’s still an important topic.) Or are you asking about why their asset allocations should be different given that they’ve made different Social Security choices?

  5. “The remainder of Bob’s portfolio — so, somewhere in the range of $438,800 (i.e., $650,000 minus 8 x $26,400) — should probably look roughly the same as Allan’s portfolio.”

    ???? Seems to me that Bob’s portfolio should be more aggressive than Allan’s. If I’m Bob and I end up at age 70 with less money than Allan has, then my goal would be to invest more aggressively with the portion of the portfolio that is not earmarked to be spent so that I’d have more money than Allan at that age. What other reason is there to hold off on taking SS early, assuming you have assets that will cover you until you start drawing SS.

    I thought I had a fairly good grasp of these issues, but now I’m totally confused.

  6. Well, at age 70, Bob has less money than Allan, but he needs to spend significantly less from his portfolio per year: $13,600 rather than $25,000. (And that’s Part 1 of the case for holding off on Social Security — Bob has a lower likelihood of running out of money than Allan because he’s using a lower long-term withdrawal rate. Part 2 is that in the event that their portfolios perform very poorly and they do run out of money, Bob will be in a better position than Allan given that he’ll be left with $26,400 of Social Security per year rather than just $15,000.)

    As to the topic of this particular article though, I think the reason it makes sense for Bob to have a higher amount of safe assets is simply that he’ll be spending much more of his portfolio in the near-term.

    By way of analogy, if I was saving for something (let’s say a downpayment on a new home), and I planned to spend the money just a handful of years from now, I would probably choose to invest the money quite conservatively.

    As far as the rest of the portfolio, Bob has about $438,800 to satisfy $13,600 of annual expenses. That’s a 3.1% withdrawal rate starting at age 62. Allan has a $650,000 portfolio, with which he has to satisfy $25,000 of annual expenses. That’s a 3.8% withdrawal rate starting at age 62.

    In either case, I’d probably opt for a simple middle-of-the-road portfolio — perhaps anywhere from 30% stock to 70% stock.

  7. I was a bit lost as to the conclusion of the post as well, but your follow up comments helped clear things up a bit.

    I would say that both Bob and Allen are set up pretty nicely and should have few money issues to deal with given their expected expenses and portfolios.

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