“Older Americans Invest Like 30-Year-Olds.” So reads the headline of a news story by Anne Tergeson on the front page of the July 6 Wall Street Journal. (The electronic version, published July 4, has a somewhat different headline: “America’s Retirees Are Investing More Like 30-Year-Olds.”)
She interviews people about their strategy but, except for the case of Wayne Winquist, the reader gets very little feel for the net worth of the people being interviewed.
There’s an even bigger problem. Although she mentions one couple living “mainly on Social Security benefits,” that’s the only mention of Social Security.
Here’s what you should know as someone thinking about your investment portfolio especially if you’re in your sixties or older: Social Security is like an inflation-indexed bond.
Let’s say you’re 67 and have a spouse who’s also 67 and you’re about to start taking SS benefits. Because you’ve been taxed heavily for these benefits for, probably, over 40 years and because many of those years have been high-income ones, you and your spouse get $60,000 in SS benefits annually. Let’s say you’re both relatively healthy and both expect to live for another 20 years.
Because SS benefits are indexed for inflation, you get annual “coupons” as if your SS is a bond. What’s the value of the bond? That depends on the interest rate, of course. A principle I taught my students in my Cost/Benefit Analysis course is that you discount real magnitudes using real interest rates. Your real benefit each year is $60,000. The value of the Social Security “bond” is the present value of a stream of income of $60,000 for 20 years. Let’s say the real discount rate is 2%. Then the value of the SS bond is about $981,000. You have, in essence, a $1-million inflation-indexed bond.
So let’s say that you’ve invested all your retirement assets, other than your house, in a stock index fund like Vanguard Total Market Index. Let’s say that the value of that currently is $1.5 million.
So now it doesn’t look as if your retirement net worth is heavily into stocks. In this case, 60% of your net worth (not including the equity in your house and any other major assets) is in stocks.
If I were to go a financial advisor to talk about my retirement (I don’t because I trust myself) and he/she didn’t say in the first meeting something like “Think of your Social Security benefit as an inflation-indexed bond,” I wouldn’t return.
READER COMMENTS
Charlie
Jul 9 2023 at 11:04am
This is not good investment advice. At best, there is controversy over whether to consider Social Security (SS) to be an inflation-indexed bond. Good investment advisors should be able to explain how SS is different from an inflation-indexed bond.
SS is more like an inflation-indexed deferred annuity, or single premium immediate annuity (SPIA) once a person is receiving benefits. One could compare the price of an inflation-indexed deferred annuity or SPIA to a market portfolio of bonds that could be used to purchase the annuity, but they are not the same thing.
Some important differences are:
SS benefits are not received for only 20 years; they last for a lifetime.
It isn’t possible to rebalance a portfolio using the value of a SS “bond”.
SS has survivors benefits.
Heirs do not inherit the remainder of your SS “bond” when you die.
It’s simpler to view SS as a real cash flow that reduces the amount of withdrawals that an investment portfolio needs to generate in retirement.
Additional analysis is available in the Bogleheads Wiki: Social Security as an investment
David Henderson
Jul 9 2023 at 2:17pm
To be clear, I don’t give investment advice; rather, I was giving advice about how to judge financial advisors.
All of your criticisms are correct.
Question: If you knew nothing about finances (and clearly, given the knowledge you’ve shown above, it’s probably hard to put yourself in that position), would you want a financial adviser to give you advice without mentioning the present value (however calculated) of your Social Security benefits?
vince
Jul 9 2023 at 12:44pm
Charlie mentioned some important differences. Some additional ones are liquidity and taxation. You can convert the bond to cash at any time if you prefer.
Taxation of both sources are devious. With an inflation indexed bond, you’re taxed on return of inflated principal (but not uninflated principal). With SS, joint retirees get a $32,000 exclusion, but that exclusion isn’t indexed to inflation and hasn’t changed since 1984. With inflation, more and more nontaxable SS will become taxable SS. The equivalent exclusion today should be about $90,000. I’m not sure why there isn’t a demand for the adjustment.
Thomas L Hutcheson
Jul 9 2023 at 2:30pm
We are lucky the is any taxation of SS payments. Most benefits like the value of Medicare or employers “provided” health insurance are not taxable at all. :).
vince
Jul 9 2023 at 3:09pm
Who is lucky?
Thomas Hutcheson
Jul 11 2023 at 12:26pm
Citizens in general/taxpayers in general. (As a SS beneficiary, it would not be “lucky” for me personally.)
Vivian Darkbloom
Jul 9 2023 at 4:02pm
“With SS, joint retirees get a $32,000 exclusion, but that exclusion isn’t indexed to inflation and hasn’t changed since 1984.”
It’s not really a “$32,000 exclusion” because it is a re-iterative calculation. In determining the amount of social security benefits that are excluded, the threshold of $32,000 (joint filers) refers to “combined income” which is a defined term. The term refers to the sum of non-taxable interest income, adjusted gross income and one-half of social security benefits. Thus, for example, if the sole source of income of a married couple were $60,000 of social security (as in the text example), none of it would be included in income because their preliminary “combined income” would only be $30,000.
I don’t think it is possible to express the “exclusion” as a fixed amount. The amount of benefits not taxed can be more or less than $32,000 depending on one’s mix and amount of income. A better description would be that 0 percent, 50 percent or 85 percent of your benefits are taxable, based on a (too) complicated formula.
vince
Jul 9 2023 at 6:23pm
Vivian,
It’s an exclusion based on an intricate formula, as you explained. I didn’t want to get into that much detail. My point is that, eventually, with inflation and no adjustment to the exclusion, what is nontaxable SS today will become increasingly taxable.
At $65,000, the couple would have adjusted gross income today. In 1984, the equivalent SS, $23,000, would have none. Now consider adding some additional income.
David Seltzer
Jul 9 2023 at 6:37pm
David, I suspect the PV ($981,300) of a stream of $60,000 per year for 20 years is calculated using the PV formula for an ordinary annuity. As my wife is still employed, I use that calculation to determine the PV of SS benefits using 2% as a discount. I include it in my net worth with a provision. Given my health, the actuarial probability I live another 20 years is .87. My expected PV is weighted by .87. As an aside. My credit score is very high. I receive 0% offers from banks with up to 21 months. The transaction fee is 3%. I take the PV of those payments and purchase treasuries paying 5%. I would say it’s a classic arb, but if I mort before the debt is sunk, the strategy fails.
David Henderson
Jul 9 2023 at 7:37pm
Nice.
BTW, could you provide the link to compute life expectancy? I found a good one a few years ago that included questions even on my grandparents’ age at death. I haven’t found as complete a one since then.
David Seltzer
Jul 9 2023 at 8:07pm
David, SSA Life Actuarial Tables is comprehensive. I did my own survival calculation using their numbers. I hope this helps.
Oscar Cunningham
Jul 10 2023 at 5:27am
Another factor is absolute wealth levels. Richer people should be more risk neutral. The couple in your example will probably end up with an income close to $200,000 once you impute rent. They can afford to take the risk that their investments will fall to 50%, since a $100,000 income is still livable. A younger, and hence likely poorer, couple would not be able to do whether the same loss.
MarkW
Jul 10 2023 at 8:46am
This is the way we tend to look at the role of Social Security in our retirement portfolio. One concern, though, is though both of us are in excellent health and not yet in retirement, the thing about social security is that in the case one of us dies, the survivor gets, essentially, just the larger of the two checks, not both, so it’s not as valuable as it might appear. Given our overall financial situation, that’s not really a serious concern, but for many people it is.
Thomas Strenge
Jul 10 2023 at 11:48am
Context is everything. In a high inflation period, being invested in real assets is a prudent strategy. Personally, I would be all in on stocks if I don’t trust the value of cash and bonds in an inflationary environment.
David Henderson
Jul 10 2023 at 12:49pm
You write:
True. It’s important to recognize, though, that inflation can hurt real assets like stocks because of the interaction of the corporate tax system with inflation. Although maybe by “real assets” you meant real estate. I’m not sure.
You write:
You’re young and so that makes sense. Plus you don’t know how much of SS will be there for you. By the time you hit your late 60s, there will have been lots of changes, none of which is easy to predict.
My post was aimed at people in their mid-60s or older. They can regard the Social Security “bond” as an inflation-indexed bond.
vince
Jul 10 2023 at 3:58pm
David Henderson wrote: “My post was aimed at people in their mid-60s or older. They can regard the Social Security “bond” as an inflation-indexed bond.”
A couple other points about SS and inflation are worth mentioning. One is the lag in indexing. During each year, until the next January increase, you’ve lost purchasing power.
Another is the CPI inflation won’t maintain your relative standard of living. If you’re joint income is at the median household level, and you only get CPI increases, you will drop below the median household level as the economy grows.
robc
Jul 11 2023 at 11:36am
However, isnt the purpose of the CPI-based increase to maintain absolute standard of living, not relative?
vince
Jul 11 2023 at 12:17pm
Which standard is your retirement objective?
robc
Jul 12 2023 at 10:50am
Absolute.
My retirement spreadsheet is based off a certain expected income stream…it adjusts for inflation, but not for change in relative living standards.
Right now it approximates retirement as of 2/5/2038. Actual market conditions could change that in either direction (as well as other changes I could make, bumping up amount of 401k, etc).
David Henderson
Jul 11 2023 at 5:14pm
Yes. And actually, because the CPI overstates inflation, it does give a slightly higher standard of living over time.
nobody.really
Jul 13 2023 at 3:03pm
This gives new meaning to the standard complaint that an advisor “generates low returns.”
Comments are closed.