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 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 financials 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

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What's been said:

Discussions found on the web
  1. PanamanianStrongman commented on Aug 04

    Social security is simply longevity insurance. Personally I see no need to categorize it further.

    • Steve commented on Aug 05

      Social security has cost of living adjustments, so theoretically it is also inflation insurance as well

      • Ben commented on Aug 05

        I agree all around here. And both risks are things many don’t spend enough time on.

  2. Grant commented on Aug 05

    I agree, Ben. I think it’s more important to focus on your risk tolerance wrt to your portfolio. It’s no point regarding social security as part of your bond allocation, therefore increasing equities in your portfolio beyond your risk tolerance.

    • Ben commented on Aug 05

      Yup part of a plan for sure but it’s not an asset class or investment option.

  3. Steve commented on Aug 05

    There are 3 risks: principal risk, longevity risk and inflation (purchasing power) risk. I think pensions and social security should be considered as part of your fixed income portfolio. If you ignore it, and set your allocation without regarding the fixed income , you may be too conservative and be exposed to longevity and inflation risk. If you stay within your risk tolerance, you should be able to have more equities in your portfolio for the other 2 risks I mentioned above. Many if not most time, investors only look at risk tolerance when doing asset allocation, so they are too conservative. Later in life they face the two less prominent risks, longevity and inflation.

    • Ben commented on Aug 05

      It depends why you invest in fixed income in the first place. Is it for yield? Diversification purposes? Dry powder for rebalancing? My sense is fixed income is for keeping up with inflation and taxes and providing diversification benefits during stock market sell offs.

  4. John Thees commented on Aug 08

    John Bogle disagrees. He advocates for, or advocated for in the past, considering SS and pension income as being a bond for portfolio allocation purposes. Steve’s comment reflects what Bogle has said in the past.

    • Ben commented on Aug 09

      Yeah I’ve seen where Bogle says treat it like an average of a $300k bond position. It all still comes down to how much risk you’re willing and able to take on in stocks, no matter how much income you have coming in.

      • John Thees commented on Aug 10

        When I first read Bogle’s opinion, many years ago, he said to multiply the annual income from a pension or SS by 14 to come up with the value of a bond that would produce that income stream. Now that he is much older he has become much more conservative regarding holding stock assets.

        • Ben commented on Aug 10

          Interesting formula. I guess maybe that one works with his age-based asset allocation formula where your age equals your stock allocation.

  5. John Thees commented on Aug 10

    What I read way back when dealt with the need to not inadvertantly overweight one’s bond allocation relative to stocks. The point was that after capitalizing one’s income stream and taking it into account in the allocation process, if the number was a lot higher than the age based formula comes up with for bonds, one should use the stock assets allocation based on the age based formula to determine the percent of stocks in the portfolio. Then the balance (percent) should be bonds.

  6. Doug commented on Aug 12

    Social Security is an annuity, not a bond. You can back into the present value of a stream of social security payments with some assumptions and a financial calculator.

    A quick example:
    PMT = $1,000/mo or $12,000/year
    N = 40 years (or whatever your life expectancy is, minus your current age. You can subtract a few years for conservatism’s sake)
    I = 3% – risk free rate at the chosen duration (N). If you think the U.S. government isn’t 100% good for the money, then increase accordingly
    FV = $0. This is the key difference between bonds and annuities. Bonds (hopefully) repay in full at par.

    Punching these figures into my trusty approved-for-CFA-exam TI-BA 2+ results in a…

    PV = $277,377

    I would allocate this to “bonds,” due to the risk/volatility of the payment streams, not because this is actually a bond.

    • Ben commented on Aug 12

      The annuity label makes more sense to me too. But I still think you have to take into account your ability to deal with volatility in your portfolio after accounting for all income streams. It’s not only your ability to take risk, but also how much you can actually stand to take.

  7. ngbstl commented on Aug 12

    Great piece. This reminds me of an article I read (I think by Alan Roth) a while back. He was suggesting that you should count your home as a “negative bond” within your investment portfolio, and calculate your asset allocations accordingly. Your comment in this case that, “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,” was the response I had to his proposal. These things are expressed as income/liabilities, not as holdings, as they don’t actually have the attributes that define various assets, and they don’t actually impact the value of your portfolio.