This in one of the greater misconceptions in the investment landscape, and unfortunately, a misconception further misrepresented on Seeking Alpha. Retirees deserve better and should know better. Heck, even investment legend Jack Bogle gets this one wrong, or should we say that he was simply misunderstood.
Now, there are a lot of bad ideas out there, but this one might take the cake due to the severity of the consequences - impairing ones retirement plans. It might be a good way to turn a successful retiree into a Walmart (NYSE:WMT) greeter. We don't want to see that happen.
The idea or proposition put forth from some writers is that you can or should monetize the 'value' of your total potential payments from your Social Security and put that amount on the fixed income side of the ledger for your investment portfolio or total retirement financial picture. The problem of monetizing your Social Security is that it can't be monetized. It's no different than suggesting that you'd like the total value of your dividend payments for the next 20 years - you'd like them upfront if you don't mind. Well, you can't have your Social Security payments moved forward to help in a time of need, just as you can't have your dividend or bond payments paid in full, in advance.
But in this article on Seeking Alpha Bogle on Favoring Dividends and Capitalizing Social Security, there it is. There's the suggestion that you can or should capitalize social security. That would be in the running for the most dangerous article on Seeking Alpha.
Here's the problem. The concept and the article suggest that you could count the Social Security as the fixed income component of your portfolio. That's right, monies held by a government agency (heck, some of the potential SS payments may not even exist yet as they'll come from future taxation or SS contributions) can be moved to your portfolio allocation. That would mean that if a retiree has a $350,000 stock portfolio and Social Security 'value' of $350,000, the asset allocation is 50/50. A nice balanced portfolio. I kid you not. This was not written for The Onion. And, it would not be a joke for a retiree should they embrace this notion.
From that article ...
But if you capitalize your SS rights, your asset allocation really is this: 50-50.
Now, The Onion is famous for absurd headlines. This one might read "Wisconsin Retiree Asks Government For Full Lifetime Social Security Payments In Advance. Government Says They'll Think About It And Get Back To Him'.
Here's the problem with the above retiree asset allocation picture, aside from the fact that the blue portion of the chart (monies) is not there. Retirees face sequence of returns risk with respect to stock component of their portfolios. While a growth component is crucial for retirees to help them maintain an aggressive spending rate and combat inflation, the growth component can carry risks due to volatility. In a market downturn, a retiree will have to sell more shares to create income. The total value of the portfolio can fall by an incredible amount.
Here's that retiree with $350,000 invested into US stocks represented by the S&P 500 index. The retiree has a 4% spend rate that is inflation adjusted. That retiree is harvesting $1,167 monthly from their portfolio. The time period is January of 2008 to end of 2011. The chart is courtesy of portfoliovisualizer.com. As always, past performance does not guarantee future returns.
In the above unfortunate scenario, the retiree has faced that sequence of returns risk due to finding an unfortunate retirement start date, right before a major market correction. The portfolio is still underwater after 4 years, and in its worst days and weeks, the portfolio value had declined to $169,824. Now, it could have been worse, many retirees found the start date of January of 2000. The period is January of 2000 to end of 2003.
Of course, historically, there was a way for retirees to make it through the last two recessions with simple balanced asset allocation - such as that 50% stock to 50% bond allocation as per the chart above. The only asterisk is that the fixed income component actually has to be there. Ha.
Ironically, here's my previous article entitled How Retirees Made It Through The Last Two Recessions. That article demonstrates how managed funds from Vanguard in the form of a Balanced Growth Model (VWELX) and a Balanced Income Model (VWINX) would have helped retirees make it through the recessions with flying colors. The difference, or key that is, is that the Fixed Income component was real - it was in bonds.
The way to protect against sequence of returns risk is to hold assets that are non-correlated or lesser correlated to stocks for those months or years when the stocks are under severe pressure. The problem with monetizing your Social Security in an asset allocation sense is that the money is not accessible, it's simply not there. Your Social Security cannot come to your rescue. It is a fixed monthly payment and nothing more. Social Security is used to calculate your potential overall income in retirement. It's a different basket that might have some other friends such as an annuity or private pension.
The investment portfolio is the investment portfolio. It is its own beast. That investment portfolio also has the potential to create an income stream.
The above scenario and investment truths were put best by the esteemed investment writer and author of several books Paul A. Merriman. Here's the article - Social Security Is Not An Asset.
If you confuse assets with income, you are making a mistake in the way you think about your money. And that can lead to mistakes in the way you manage your money.
Even Vanguard Group founder John Bogle has endorsed the idea that Social Security has a "present value" that can be counted as part of a portfolio. But he and other advisers should know better, as should anybody who has taken even an introductory college accounting class.
And on the severity of 'all of this' ...
In a serious bear market, that heavy equity allocation could wipe out your portfolio's ability to keep generating the income you need for retirement. You'd still have your Social Security, but you might not have much else. You could be forced to drastically cut back your lifestyle - an unfortunate result that started when you didn't think clearly about this.
Now, I know that many dividend devotees (count me in on that moniker) will state that it all doesn't matter because "I'll just spend the dividends that will keep increasing over time, and combine that with the Social Security checks". Sure, but from one of my recent articles Retirement Funding: It Comes In Stages, here's the performance of a High Dividend Index Fund and a REIT Index Fund portfolio at a 50/50 allocation during the last recession. The portfolio has a 4% inflation adjusted spend rate. In the recession, the portfolio value took a massive hit, the dividends were cut for both index funds.
That income seeking retiree might face the sequence of returns risk, along with the portfolio income risks as income declines and asset sales are required to compensate for declining portfolio income. Of greater concern might be watching the portfolio value decline by some two thirds. Once again, Social Security cannot come to the defense of declining income, or falling asset prices. I also do not think many retirees would be comfortable watching their portfolio value get cut in half, never mind a more severe haircut.
In retirement, I am counting on generous dividend payments and share harvesting, and I am also counting on those Government pension checks. But I will certainly not be counting on the pension to ever pick up the slack for the investment portfolio. I'll leave that risk management to some real assets with some real value - bonds and cash.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Dale Roberts is an Investment Funds Advisor at Tangerine Investment Funds Limited a subsidiary of Tangerine Bank, wholly owned by Scotia Bank; he is not licensed to provide professional advice on stocks. The opinions expressed herein are Dale Roberts' personal opinions relating to his experience as an investor and are not those of Tangerine Bank or its subsidiaries and/or affiliates. This article is for information purposes only and does not constitute investment advice or an offer or the solicitation of an offer to buy or sell any securities. Past performance is not a guarantee and may not be repeated. Investment strategies are not suitable for everyone and you should always conduct your own research or speak to a financial advisor.