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Social Security Is Not an Asset

Reprinted courtesy of

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One bit of financial planning mischief that rears its ugly head from time to time is the notion that Social Security is a substitute for fixed-income funds in a retirement portfolio. My opinion about this is unequivocal: Absolutely not.

MarketWatch columnist Andrea Coombes wrote about this provocative topic recently, quoting several financial professionals who suggest that investors “may be missing out on bigger gains” in their retirement portfolios unless they count Social Security as part of their overall asset allocation.

If investors consider Social Security as part (or all) of the fixed-income allocation in their portfolio, the thinking goes, they could afford to invest much more heavily in equities (and much less in bonds).

Coombes cited this theoretical example: If you had $300,000 worth of Social Security benefits and $700,000 of investments, you could consider that in effect your portfolio was worth $1 million. If your goal were to control risk by having only half your investments in equities, then you would need only $200,000 in bond funds because you would already “have” $300,000 in fixed income.

More equities means more gains. Conveniently, the proponents of this idea neglect to mention that more equities also means more risk — not something most retirees want.

Though this idea is appealing, it’s misguided, and it will lead investors astray. Let me tell you why.

The idea is fundamentally flawed. Regardless of mumbo-jumbo about placing a “present value” on government retirement payments, Social Security is not — and cannot be — part of anybody’s portfolio.

A portfolio is composed of financial assets. A financial asset is something that can be sold. Social Security cannot be bought and sold. Because of that, it has a market value of zero.

Don’t get me wrong. I’m certainly not saying Social Security is worthless. On the contrary, it’s very valuable. But it’s not an asset.

If your investments are worth $700,000, then that’s the size of your portfolio. Your assets don’t magically grow by $300,000 or more just because you receive your first Social Security check.

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.

As I wrote in 2009, this isn’t an arcane distinction.

If you’re receiving $32,500 a year in benefits and you expect to live another 20 years, you might think you have an asset worth $650,000. But those payments will last only until your death; at that moment, your “asset” vanishes completely.

So what’s the real value of your Social Security? Unless you are on your deathbed, you have no way to know.

That’s the theoretical reason why this is a bad idea. The practical reason is just as important.

Assume you have investments worth $600,000 and somehow, against my advice, you decide that your Social Security is worth $400,000. If you conclude that your total portfolio is worth $1 million, and you want to be conservative, you might decide to invest half your money in stock funds ($500,000) and the other half in fixed-income.

If you count $400,000 in Social Security toward the fixed-income part of that portfolio, you’ll own $100,000 in bond funds and $500,000 in equity funds. That means your investment portfolio will be more than 80% in equities instead of the 50% target you set. That puts you at greatly increased risk.

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.

Social Security is a great thing to have coming in every month. Fortunately, there’s a correct way to treat it in your retirement planning.

The right approach is to think of Social Security as income that reduces the amount you need to take out of your portfolio in retirement.

The basic formula is this:

  • First, compute your cost of living in retirement.That’s what you need.

  • Next, add up the income you already have (or will have) from Social Security, pensions, fixed annuities and other sources. That’s what you have.

  • · Finally, subtract the second number from the first, and the difference is what you need from your investment portfolio, either monthly or annually depending on how you do the calculations.

When you think about Social Security this way, you are getting it right.

And as I have pointed out many times, knowing how much income you need from your portfolio is an essential building block in getting your finances to do the most for you in retirement.

Richard Buck contributed to this article.