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Why retirees should factor Social Security into their asset allocations

It’s a topic that divides planners as they talk about asset allocations — should Social Security be considered an asset and factored into a retiree’s investment allocation?

Some consider this TIPS-like income-producing instrument to be a key asset in retirement allocations and others prefer to think of it as inflation-adjusted income that should not affect the allocation of other investable assets.

For many retirees entering retirement, revisiting their allocation is important. Now that they have transitioned from accumulating wealth to drawing down their portfolio, the allocation of these assets is vital. A strategy that’s too aggressive, coupled with a major market downturn, can deplete the portfolio beyond repair. On the other hand, a portfolio that’s too conservative could mean the nest egg won’t grow enough to provide lifetime income. For that reason, many retirement portfolios maintain between a 40% and 70% equity allocation.

That said, often these portfolio allocations don’t include everything that a client owns. The calculations only take investment assets into consideration. What might the allocation be if other income-producing assets or income streams were factored in? A pension or Social Security will provide income for life, and as such, these assets can be viewed as bond-like instruments in terms of their cash flow. With this in mind, should the other portions of retirees’ investment portfolios actually be more aggressive to adjust for these income streams?

In talking to advisors, I feel there’s an important distinction has to made as to when Social Security could be viewed as an asset. During the accumulation phase, Social Security is just a promise of future income (as well as a tax to fund it) to begin at a time you determine between ages 62 and 70. To design an allocation based on a future promise, and no underlying asset, seems foolish for most investors.

Getting clients to embrace this strategy can be challenging ... The 2008 recession still holds a bitter taste in their mouths.

Instead, I believe it’s better to wait until clients are near retirement (say, 12 months out from taking Social Security payments) before thinking of it as an asset class. And then their portfolios can get a bit more aggressive as this income stream enters into the retirement cash flow.

Margery Schiller of M K Schiller Consulting, a fee-only firm in Sarasota, Florida has walked clients through these discussions, and she has seen some retirees understand and embrace this concept. Once they knew they could count on Social Security payments, “those who were originally equity-adverse began to see how acceptable it would be to increase their equity exposure.”

While this is an easy issue on paper, taking this strategy into a client meeting and getting approval to adjust a client’s allocation is difficult.

Regardless of how much income clients are generating and how much they need from their portfolio, they still view their investments as their nest egg, and would feel poor should it drop below a certain number.

I’ve worked with couples who are nearing retirement and between the two spouses will receive private and government pensions, in addition to Social Security. These income streams alone will fully cover their needs. But even in those cases, it is hard to convince these clients that the vast majority of their investment portfolios should be in equities – I would say roughly 80% to 100%.

They see the downside risk this poses with the 2008 recession still holding a bitter taste in their mouths, even though it was 10 years ago and the ensuing economic recovery has boosted their savings above the original levels.

No matter how I pose this advice to clients, it’s hard to get them to pull the trigger, but I’ll keep trying. It makes academic sense to make this change, but in the end, feeling secure in retirement is about more than just an academic exercise. Overcoming the emotional hurdles that come along with investing can make this strategy a hard one to implement.

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