Should Social Security Be Considered a Bond?

A reader asks:

Should Social Security income be considered as part of the bond portion of a retired person’s asset allocation, thus increasing the stock portion?

I’ve seen a number of opinions, articles and blog posts over the years about this question. It seems people tend to take a hard line and either say yes it definitely should or no it definitely should not.

As with most things in the world of financial planning, there’s always a middle ground and a few different ways to look at things. I always like to think about these types of problems in a different light and back into the answer. The two biggest risks or worries for retired investors should be (1) outliving your wealth and (2) meeting your spending obligations.

When creating a holistic financial plan you always have to take into account all financial assets, which include your investment portfolio, real estate and other sources of income or human capital. Based on these assets, investors need to figure out a sustainable withdrawal rate that gives them a high probability of achieving portfolio longevity.

To get to that number you first have to start with an estimate of how much money you plan on spending each year, in excess of other income sources. That means you account for income from social security, pensions, real estate rentals or part-time jobs. Once you’ve accounted for these fixed or variable sources of income, you should be able to figure out how much of your spending needs must be met by your portfolio.

When you know have a reasonable approximation of the amount of money you need to draw down from your portfolio over time you can then create an asset allocation plan to account for those needs. You try match your assets with your liabilities. It’s never going to be a precise exercise, but you try to match your short and long-term time horizons with your risk profile and create a portfolio that takes it all into account.

So I wouldn’t start by trying to quantify your social security in terms of making it a bond allocation by calculating a net present value of your future payments. That seems too complicated and abstract to me because you can’t simply cash out that income stream if you need more money that it provides. The fair value is also determined by a number of assumptions that are hard to predict, the most important one being how long you’ll live to spend it. Trying to turn social security into a bond allocation could also skew how much risk you take in your portfolio. That income may not provide much comfort during a bear market if you have an equity-heavy portfolio because of it.

But that doesn’t mean you completely ignore social security in your financial plan. It’s just that it’s an asset and not an investment. It’s an income stream not a portfolio holding. You take it into account, but I feel there’s no reason to make it more complicated than it has to be. First and foremost, think in terms of spending and then figure out how that spending will affect your investment choices and tolerance for risk.

Further Reading:
Rebalancing With Required Minimum Distributions
Time Horizons & Withdrawal Rates in Retirement