Archives for March 2020

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Social Security in a Down Market: Does it Make More Sense to File Early?

The most common question I’ve gotten from readers over the last few weeks has been whether the current stock market downturn is a point in favor of filing for Social Security earlier than would otherwise make sense.

Let’s try to tackle this question in a few different ways.

Which Assets Are You Spending Down?

As we’ve discussed in various places in the past (e.g., here, here, or my book), the money that is being used to fund the delay should be invested in something like a short-term bond fund, bond ladder, or CD ladder. That is, the portfolio that’s being used to delay Social Security should be (mostly) inoculated against market risk and sequence of returns risk.

Here’s how retirement expert Steve Vernon explains it:

In the years leading up to retirement, an older worker might want to use a portion of their retirement savings to build a “retirement transition bucket” that enables them to delay Social Security benefits. While there’s some judgment involved with the necessary size of this bucket, a starting point would be an estimate of the amount of Social Security benefits the retiree would forgo during the delay period.

[…]

The retirement transition bucket could be invested in a liquid fund with minimal volatility in principal, such as a money market fund, a short-term bond fund, or a stable value fund in a 401(k) plan. This type of fund could protect a substantial amount of retirement income from investment risk as the worker approaches retirement, since the retirement transition bucket would be invested in stable investments and Social Security isn’t impacted by investment returns.

In Social Security Made Simple, I suggest something similar, using a CD ladder instead.

More broadly, assuming that you have bonds (or other fixed-income) in your portfolio, the Social Security decision is primarily, “do I want to exchange some bonds (or other fixed-income) for more Social Security?”

And that decision isn’t especially impacted by what the stock market has done lately. It is impacted by market interest rates. Right now, real interest rates are super low, which is a major point in favor of delaying Social Security (because the bonds that you’re giving up have lower expected returns than they would if interest rates were higher).

Do the Analysis: Using a Calculator

One useful thing to do when answering the question of “do I want to exchange some bonds for more Social Security?” is to use a Social Security calculator. Naturally, I’m partial to Open Social Security because:

  1. It’s free,
  2. It’s open-source,
  3. It uses more realistic mortality modeling than other calculators do, and
  4. I built it, so I’m super duper biased.

But use a different calculator if you’d like.

When you do that analysis, you will find that in most cases:

  • Spending down bonds in order to delay filing is very beneficial for the higher earner in married couples (with some specific exceptions, such as when there is a minor child or adult disabled child, or when the lower earner does not qualify for a retirement benefit of his/her own and will be at least full retirement age by the time the higher earner reaches age 70);
  • Spending down bonds in order to delay filing is somewhat beneficial for unmarried people (i.e., beneficial on average — more beneficial if you’re in good health and less beneficial if you’re in bad health); and
  • Spending down bonds in order to delay filing is not especially beneficial for the lower earner in married couples. (Though if the lower earner is significantly older than the higher earner and/or both are in very good health, delaying would be more beneficial.)

What About Risk?

A common counterargument to the idea of spending down bonds more quickly in order to delay Social Security is something to the effect of, “but then I’m left with a higher stock allocation! And that’s too risky!”

But that makes no sense. Spending down bonds in order to delay Social Security doesn’t leave you with any more dollars in stocks than you would have had otherwise (i.e., when we look at dollars, which is what matters, rather than percentages, you have not increased your exposure to stock market risk).

For example if you have $400,000 in stocks and $400,000 in bonds — and you spend down $150,000 of those bonds in order to delay Social Security — you still have $400,000 in stocks. A stock market decline of a given percentage would not result in a larger loss than it would have previously.

In fact, a strong case can be made that a stock decline (or, in today’s case, a potential further stock decline) becomes less damaging when you exchange bonds for Social Security. The ultimate reason that stock market declines are a source of risk for retirees is that they mean an increased probability of outliving your portfolio. But if you have more Social Security income and less bonds:

  1. You are less likely to outlive your portfolio, because the Social Security income lasts for life and because it supports a higher level of spending than bonds do (which allows for you to spend from the rest of the portfolio at a lower rate), and
  2. If you do outlive your portfolio, you’re in a better situation with a higher Social Security check each month.

And yes, in some cases, it can make sense to spend bonds all the way down to zero in order to delay Social Security.

In case you think that that sounds crazy, here’s what Wade Pfau wrote in his recent book Safety-First Retirement Planning:

As for bonds, ultimately, the question is this: why hold any bonds in the part of the retirement portfolio designed to meet spending obligations? The income annuity [Mike’s note: Social Security is an income annuity.] invests in bonds and provides payments precisely matched to the length of retirement, while stocks provide opportunities for greater investment growth above bonds. Bonds alone hold no advantage.

Or here’s what Steve Vernon has to say:

Our analyses support investing the [unannuitized portion of the portfolio] significantly in stocks – up to 100% – if the retiree can tolerate the volatility. The resulting volatility in the total retirement income portfolio is dampened considerably by the high proportion of income produced by Social Security, which doesn’t drop if the stock market drops.

Spending/Withdrawal Rates

It can also be helpful to look at spending rates (i.e., the percentage of your portfolio that you’re spending each year in retirement).

Forget about Social Security for a moment. And forget about what the market has done over the last few weeks. Just look at where your portfolio balance is right now in relation to your spending. That is, what is your current spending rate when expressed as a percentage of your portfolio balance?

Almost certainly, your current spending rate (as a percentage) is noticeably higher than it was a month ago. Maybe it’s still low, and you’re not worried at all. Or maybe it’s now high enough that you’re starting to worry.

When a retiree’s desired spending level is high relative to their portfolio balance, that’s precisely the scenario in which annuitizing (i.e., buying a lifetime annuity with a part of the portfolio) is most likely to make sense.

Lifetime annuities allow you to safely spend more money than a stock/bond portfolio. We’ve discussed this before, but in brief the idea is that with lifetime annuities, the annuitants who die prior to their life expectancy end up subsidizing the retirement of people who live beyond their life expectancy. So each individual person can essentially spend an amount that’s based on their life expectancy, whereas in a normal (no-annuity) situation you have to spend less because you don’t actually know how long your retirement will last (e.g., spend a low enough amount each year such that you’d be confident your portfolio would last 30 years, even if your life expectancy is only 20 years).

And if you’re in a situation where a lifetime annuity makes sense, delaying Social Security is the best annuity around. (Though again, that’s much more true for higher earners in married couples and less true for lower earners in married couples.)

To Summarize

  1. Use the Open Social Security calculator. It helps you identify the filing age (or combination of filing ages) that is most likely to maximize the total amount you can spend over your lifetime.
  2. If you are concerned about the possibility of depleting your savings, please note that exchanging bonds for Social Security (i.e., spending down bonds in order to delay filing) generally has the effect of a) reducing the likelihood that you outlive your savings and b) reducing the ramifications if you do outlive your savings (i.e., you’ll be left with more income than if you hadn’t delayed).
  3. As far as the lower earner in married couples, it is generally not particularly advantageous for them to delay (though today’s very low interest rates do make it more advantageous than otherwise).
  4. The recent stock market downturn does not affect points #2 or #3 above.
  5. The Open Social Security calculator can help you identify the exceptions to points #2 and #3 above.

Want to Learn More about Social Security? Pick Up a Copy of My Book:

Social Security cover Social Security Made Simple: Social Security Retirement Benefits and Related Planning Topics Explained in 100 Pages or Less
Topics Covered in the Book:
  • How retirement benefits, spousal benefits, and widow(er) benefits are calculated,
  • How to decide the best age to claim your benefit,
  • How Social Security benefits are taxed and how that affects tax planning,
  • Click here to see the full list.

A Testimonial from a Reader on Amazon:

"An excellent review of various facts and decision-making components associated with the Social Security benefits. The book provides a lot of very useful information within small space."

Investing Blog Roundup: Staying Healthy

Most of us have had our worlds dramatically restricted over the last couple of weeks. Meanwhile we’re inundated with news all day long — most of it bad. As much as physical health must be a priority right now, so too with mental health.

Other Recommended Reading

Thanks for reading!

What’s Coming Next? (And What to Do About It?)

A quick note: obviously, the stock market’s recent/current volatility is not the most important thing happening in the world right now. Yet of all the events going on, it’s the one I feel qualified to write about, so that’s what I’m doing, in the hope you find it helpful. Stay safe, everybody.

In terms of percentage gained/lost, last Thursday (3/12) was the 5th-worst day in stock market history. (Of the four days that were worse, three were part of the 1929 crash.)

The following day, Friday, was the 9th-best day in stock market history.

If you had your money out of the market before Thursday, you looked like a market-timing genius by Thursday evening. But if you took your money out near the end of Thursday or early Friday, you have just the opposite result: you were hit by the historically-bad day and missed the historically-good day.

Jumping in and out of the market, especially during super volatile times like this, is a high stakes game.

And it’s not an easy game to win.

When I think back to early Friday morning (and as I write this, it’s Friday evening, so that wasn’t very long ago), the things on my mind were whether my wife’s workplace would soon be implementing mandatory work-from-home, whether local schools would be closing, and things of that nature. I definitely wasn’t sitting there thinking, “maybe today will be one of the best days in stock market history.” Frankly, if anything, I would have bet on a further decline.

Let’s Try an Experiment

Below are three charts, made using the Morningstar website. Each one shows the performance of the Vanguard 500 Index Fund over a particular 1-month period. The specific dates are intentionally omitted.

Unspecified Decline #1:

Unspecified Decline #2:

Unspecified Decline #3:

In each case, the fund has fallen by a considerable amount over the month in question. Again, I’ve cropped the dates from the charts intentionally. But I promise that in each case, investors were scared.

Want to guess what happened next?

[Spoilers below.]

It depends.

Our first chart was from 9/18/1987 – 10/19/1987. The huge single-day drop at the end is “Black Monday” — the worst day in U.S. stock market history. Here’s what happens when we zoom out and show the results through the end of the following year. (You can click the image to see it full-size.)

By the end of the 1-month period in the original image, the market had finished falling. The 28% decline was the extent of it. The market’s return over the next next year was positive.

Our second chart was from 9/10/2008 – 10/10/2008 (i.e., early stages of the global financial crisis). Here’s what happens when we zoom out and show the next few months of returns.

Point being, the 27% decline in the original image turned out to be only about half of the total decline this time. The market still had much farther to fall.

But, at least for me, when I look at the first two undated 1-month charts above, there’s no way I would have known which one marks the beginning of a recovery and which one marks the halfway point of a larger decline.

So what’s the third undated chart? The third chart is the fund’s 1-month return as of today.

And I have no idea what comes next.

So I’m doing what I do when I don’t know what comes next (which is all the time) — just sticking with my same, simple/boring all-in-one fund, continuing to invest steadily, and continuing to pay attention to all the other important aspects of financial planning (tax planning, insurance, monitoring spending, etc.).

Investing Blog Roundup: All-Stock Portfolios Are Safer??

This week I enjoyed a recent article in which Allan Roth digs into a surprising set of Monte Carlo results from Fisher Investments, in which all-stock portfolios were shown to be safer than diversified stock/bond portfolios. A good reminder that you need to know what assumptions went into a given set of simulations (or into a given piece of research in general) before you know whether or not you can trust it.

Other Recommended Reading

Thanks for reading!

What to Do (With Your Portfolio) about a Likely Pandemic

As of the end of Friday the stock market was down about 13% from its peak earlier this month.

The World Health Organization has declared has declared COVID-19 a “Public Health Emergency of International Concern.” The CDC says that “current global circumstances suggest it is likely that this virus will cause a pandemic.”

These are scary times.

Because some people have asked: no, we have not made any changes to our asset allocation. It’s still 100% Vanguard LifeStrategy Growth (which is 80% stock, 20% bond).

That’s the point of strategic asset allocation, after all: to find an allocation that you’re comfortable with, even in scary times.

And this, right now, is why we spend so much time talking about risk tolerance. It’s important to know how well you tolerate risk. So take a moment to ask yourself: how well are you tolerating this risk? Right now, when you’re actually seeing and feeling some risk, is precisely the time to make that assessment.

Assessing your risk tolerance at a time when the markets are shooting upward is a recipe for disaster. When markets are shooting upward it’s easy to look at data about historical market declines and say, “yeah, I’d be OK with that.” It’s another thing entirely to actually see that your portfolio has declined by more in the last week than you’ve earned at your job in the last year — and to know that the upcoming week could be just as bad.

Another thing to take note of here is that almost nobody was talking about coronavirus even just a few months ago. Whatever the big scary thing is that sends the markets tumbling, almost nobody sees it coming. It’s always new. It’s always a surprise to most of us. It’s always scary. That’s the point.

Pick a portfolio with which you are comfortable even now.

To be clear, I don’t know if or how far the market will continue to drop. I have no idea what the next week, month, or year have in store for us.

And frankly, nobody does.

The guesses are all over the map as far as how bad the outbreak will be. And even if we knew how bad it would be in terms of human suffering, it would still be a major challenge to get a ballpark figure for what the cost would be in terms of “how much less profitable will companies be going forward, relative to how profitable they would have been if not for the virus?” Because that’s ultimately what the change in valuation comes down to.

On the whole though, businesses will keep earning money. Stocks will be profitable, eventually.

So to summarize:

  1. Market declines are scary, and a significant part of that scariness is due to the fact that they’re usually linked to some largely-unforeseen, scary real-world event.
  2. A market decline is the only time to assess your risk tolerance. Now that you are actually seeing and feeling some risk, how well are you tolerating it?
  3. You want to pick an allocation with which you are comfortable, even during the bad times. And then stick with that allocation! Don’t adjust to a higher stock allocation later, or you’ll again be caught with “too much” risk during the next downturn.
  4. Nobody ever knows what’s coming next for financial markets.
  5. Stocks will be profitable, eventually.

We didn’t make any portfolio changes. What we have done in our household is what the experts are recommending: stock up on nonperishable food, toiletries, and our over-the-counter medications. (It’s an easy action to take because there’s no downside — it’s all stuff we’ll use eventually anyway.)

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My new Social Security calculator: Open Social Security