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There is plenty to discuss and debate when it comes to Social Security.  Whether the program will be there for future beneficiaries, in what form, and taxed at what rate are just some of the valid questions to consider depending on your age and income level.

Today’s discussion is a little different.  How should you look at Social Security as it relates to your overall retirement portfolio?  Some say that Social Security is a debt owed to you by the government and, as such, acts like a government bond.  Therefore, it should be considered in a portfolio as a bond or bond-like asset when evaluating an overall asset allocation.  There is much debate on the matter and no clear answer as to whether this is a good idea.  I want to look at some of the basic pros and cons of the debate and examine why we take the stance we do in our planning process.

How Social Security is Like a Bond

In a recent interview with Morningstar, Vanguard founder Jack Bogle made the case for treating the benefit like it was part of the fixed income side of your allocation model in a portfolio.  His argument was quite simple.  Social Security delivers income, adjusts to inflation and is a benefit or promise of the U.S. government, all reflecting something like a U.S. inflation-protected bond.

How it is Not

While we embrace Mr. Bogle’s simplicity, there are, of course, many differences as well.  Social Security has no maturity date.  In a down market, you cannot create more cash from your Social Security benefit to avoid selling stock at inopportune times.  You can’t take it in a lump sum or leave to your estate as an asset.

Our Take

While both sides of the argument have merit and we certainly include Social Security benefits in our planning model, how you treat them as it relates to proper asset allocation comes down a more balanced approach.

Our current thinking on Social Security in general, in short, is that if you’re over age 55, you’ll likely receive your full benefits as promised from a program that looks almost exactly as it does today.  If you’re under the age of 55, there’s a chance that the full retirement age, means testing of benefits, taxation methods, etc. could impact benefits, but that you, too, will receive some level of benefit from the program.

Applying that thinking to our planning models, for clients 55 and older, we plan in most cases under the assumption that full benefits will be received.  For clients under 55, we
start to present scenarios where we discount the expected benefit to various
degrees based on age, income level and other factors.

Considering benefits in a plan does mean reducing the expected income stream needed from a clients’ portfolio.  This, arguably, leads to an allowance for slightly higher exposure to stocks for those with the appropriate risk tolerance and goals.  So, in some sense, yes, Social Security can have an impact on asset allocation.  That said, we do not advocate adjusting asset allocation solely based on the thinking that Social Security acts like a bond and, as such, should be included as part of the fixed income portfolio.

By not offering the same liquidity benefits as the bond funds we use in portfolios, we would be sacrificing the benefits of being able to produce income without selling stock at inopportune times or, perhaps more importantly, to buy into stocks during those “sale” opportunities.

The bottom line, optimizing Social Security benefits through traditional planning methods will continue to be an important part of our process, but taking some present value of expected Social Security benefits as part of the bond portion of a portfolio is one step too far.

Have a great week!