What is your Social Security worth and why does it matter?

When it comes to asset allocation most people only think about their portfolio in terms of stocks, bonds and cash-type investments. This is a mainstream way of thinking that leaves out one of the largest assets most people have - an annuity called Social Security. While you might think about Social Security as an income stream, it is possible to convert that income stream into a current value based on your payment amounts and life expectancy. In financial terms you are determining the Net Present Value (NPV) of your payments in today’s dollars. Thinking about Social Security in these terms can help reshape your view with regards to the amount of risk in your portfolio.  It will also lead to a portfolio that shows a much lower exposure to stocks.

For example, let’s say a couple has a $1 million portfolio that is made up of 50% stocks ($500,000) and 50% bonds/cash ($500,000). Now let’s take their Social Security payments into account. Conservatively, let’s assume their respective Social Security payments are $2,500 a month for the spouse that worked outside of the home and $1,250 for their spouse (spouses receive the greater of their own Social Security or half of their spouse’s). If we also assume they will receive these amounts for a period of 15 years (life expectancy once payments start), the Net Present Value of those payments would be $899,500 giving us a total portfolio of $1,899,500. Since these payments are assumed to be guaranteed, as they are backed by the U.S. government, we would categorize them as cash/bonds. That means that the overall allocation would be 26% stock ($500,000) and 74% cash/bonds ($1,399,500), which is a much different picture than if these payments are not considered.

You can use the following calculator to determine the Net Present Value of your Social Security payments. To give you some idea of the life expectancy to use for your calculation see the chart below which shows the probability of living to various ages.

Broadening the way you look at your portfolio will help you better understand the real structure of your retirement investments.  Including the NPV of your Social Security when assessing your overall portfolio allocation will give you a clearer picture of your real risk profile.  

Accumulation V. Distribution

A lot of people listen to Warren Buffet when it comes to investing. His ideas and strategies are great for those building their wealth like him. He has never retired despite the fact that he will turn 90 years old this year. It also doesn't hurt to have nearly $90 billion. But for the rest of us, we have to realize that there are two investment phases in our lifetime. The first being the accumulation phase. This phase occurs when we are working and contributing to the retirement plans that we will depend upon when we decide to retire. The second phase, which is called the distribution phase, is when you decide to retire and support yourself with the money you saved and invested over the years. The distribution phase requires different strategies to mitigate the possibility of running out of money or having to drastically reduce your lifestyle as you age.

In the distribution phase there are three pillars of income. They include your investments and 401(k)/IRA, Social Security, and, in some cases, a pension. The objective is to replace your earned income with these pillars so that you can continue living a similar lifestyle in retirement. 

When looking at the differences between the accumulation and distribution phases a significant factor is how you allocate your investments. In the early years of the accumulation phase an allocation close to 100% stocks is preferred because of the long time horizon you have until you will need to draw on your investments. But as you age the allocation between stocks and bonds should change. When you start to get close to the distribution phase (5-10 years out), your allocation should shift increasingly to bonds to dampen volatility and serve as a future source of regular income. NOTE: Social Security acts like an annuity that pays you a monthly income for the rest of your life with a Cost of Living Adjustment (COLA). As a result, it should be considered as a stable “asset” when designing your asset allocation plan.

Another difference is that during the accumulation phase there is no need to rebalance your portfolio since new contributions can be used to accomplish it. During the distribution phase rebalancing becomes a more complex issue because you are taking money out of your accounts. That is why it is important to hold a larger portion in safe assets, such as bonds, that will remain more stable and serve as a resource for buying stocks when their prices decline (which we all know will happen). The inverse is also true. When stocks earn sizable returns, as they did in 2019 and early 2020, it is important to take profits to fund future withdrawals by rebalancing towards bonds. Another benefit is the income that bonds will generate to further aid your withdrawals. 

The last and the most important difference between investing during the accumulation and distribution phases is behavior management. People in the accumulation phase tend to worry less about dips in the market as they have current earned income and are not in need of funds from their 401(k)’s or IRA’s. They also tend to have less free time to manage their accounts since they are busy with work, building a family, or furthering their education. During the distribution phase this all changes. You no longer have earned income and the future is already here. Market swings take on greater importance since you need the money in your retirement accounts to meet current and not so distant needs. Avoiding overreactions to market gyrations is paramount. Many times an investor feels as if they need to do something when volatility raises its ugly head. The better option is to have a strategic plan in place to avoid making short-term decisions that will have long-term negative impacts. Refer to the Investor Behavior Gap blog for more information.

Your asset allocation, diversification strategy, rebalancing tactics, and behavior management become much more important during the distribution phase and will require a greater level of care. A Certified Financial Planner professional that has experience managing clients assets during the distribution phase and has the necessary skills to help navigate both financial planning and wealth management challenges may be helpful. 

Dangers of Passive Index Investments

With investors becoming more aware of costs and expenses, many have decided to move to passive index investments. This move has allowed investors to reduce costs and obtain returns similar to the index. Passive investments or index funds can be great if used correctly and for the right person/situation. For example, a younger person who is contributing to their 401k and has a long time horizon is a great candidate. They can easily endure the ups and downs of the markets while dollar-cost averaging over their working life. For someone who is already retired or approaching retirement an index fund may not be the best option. The risk for a retiree/near-retiree is that they could hinder the longevity of their retirement capital since an index fund, by design, will match the index in both good and bad markets. A related risk involves an investor’s behavior especially during a down market. Please refer to our previous blogs about Sequence of Return Risk and Investor Behavior Gap to better understand these risks. 

Many investors do not realize the hidden dangers of investing in index funds. When it comes to indexes like the S&P 500, most of the passive funds are market-cap weighted - meaning that large companies like Apple make up a sizable portion of the index fund’s holdings. These companies have become so highly valued that the five largest companies (Apple, Microsoft, Alphabet (Google), Amazon, Facebook), account for 17.5% of the market-cap weighted S&P 500 Index. This is inconsistent with the whole idea of buying a cheap, broadly diversified index since just five technology-based stocks will have such a significant impact on the index’s performance.  To put this in perspective, as recently as 2012 the top 10 holdings in the index accounted for approximately 20% of it’s value and contained more than just technology stocks (names like Walmart, Exxon, and Pfizer). 

As a result of how they are structured, an index fund overweights stocks that have outperformed while underweighting those that have underperformed. The more those big five stocks go up the more the index funds have to buy them.  An investor that prefers to buy low and sell high will be forced to watch the exact opposite happen within their index fund. An investor is betting that whatever has been going up will continue to go up. History tells us that is a bad bet.  While growth stocks, like the technology companies mentioned above, have been the leaders for most of the past decade, history shows that rotations from growth stocks to value stocks will not be announced and can result in vast performance differences. The last time growth-oriented technology stocks substantially outperformed value-oriented stocks was in the 1990’s.  The following decade value stocks dramatically outperformed growth stocks.  

As with all things in life there are positives and negatives related to investing in passive index funds. Low costs and market matching performance work to an investor’s benefit especially during the accumulation phase of their financial lives.  That same market matching performance during the distribution phase of an investor’s financial life may work against them especially when the next bear market hits.

Sequence of Return Risk

As mentioned in our previous blog (Monte Carlo and Retirement Success), the sequence in which you earn returns plays an important role when planning for a successful retirement. A significant decline in the value of your portfolio near or at the beginning of retirement is among the most potentially destructive scenarios. This is due to withdrawals to fund your spending, the impact on future growth and a portfolio’s struggle to regain lost ground. It can cause a portfolio’s longevity to decline faster than the retirees. 

In the chart below, we show and compare the portfolio values of someone who is in the Accumulation phase (working) and someone who is in the Distribution phase and taking withdrawals (retired). Each portfolio had a starting value of $1.25 million with the Distribution phase portfolios withdrawing $50,000 per year indexed for inflation. We ran two scenarios using returns from 2008 through 2017.  In the Accumulation 1 and Distribution 1 scenarios we used the actual returns for a balanced portfolio (60% stocks/40% bonds) which reflects a loss of 22% in 2008. While the Accumulation 2 and Distribution 2 scenarios reflect the exact inverse with a loss of 22% in 2017. We can clearly see that in the Accumulation phase the sequence of returns has no impact on the final outcome since there were no withdrawals.  On the other hand, there is a sizable effect during the Distribution phase. The gap over a 25-30 year retirement would be even wider.

Nov Blog

According to data and analysis done by PIMCO, consider a retiree who had a $1 million portfolio which allocated 60% to stocks and 40% to bonds in 2007. Despite the 51% drop from October 2007 to March 2009, the portfolio would have recovered fully by 2011 and grown to about $2 million by 2017 if it had been left untouched.  In a similar scenario in which the retiree was withdrawing $50,000 each year the outcome would be far different. Even today, 12 years later, their portfolio would be worth only $1.2 million.

Another issue that can arise from a market downturn near or early in retirement is de-risking or scaling back equity exposure at market bottoms. Although this might feel better in the short- term, it can lead to longer term issues. Taking the same time period as the previous example (2007-2019), if someone had de-risked to 40% stocks and 60% bonds in 2009, the value of their portfolio would be $920,000 rather than $1.2 million. If a retiree had responded in a more extreme way and allocated their entire portfolio to cash to hide from further market erosion the portfolio value would only be $306,000.  In both de-risking scenarios, the retiree has converted temporary losses into permanent losses. 


According to Cerulli Associates, nearly 60% of individuals with advisors lack a retirement income plan and that number rises to 80% for individuals without an advisor. There are many ways to lessen the impact of potential negative returns when you are approaching or in retirement.

  1. Creating a long-term retirement funding and investment plan to which you will adhere.
  2. Tactical rebalancing (buy low, sell high/take profits).
  3. Adjusting spending in response to changes in your portfolio value. 
  4. Overweighting undervalued assets (assets that have performed worse relative to other asset classes) and underweight or take profits on those that have outperformed.
  5. Understanding the upside and downside capture of your investments, mutual funds and overall portfolio. How much does your portfolio follow the broader market on the way up and the way down? 
  6. Owning a truly diversified portfolio. Did you know that 10 stocks account for 21.5% of the S&P 500’s value and the top four (Microsoft, Apple, Amazon, Facebook) make up 12.75%.

A stock market meltdown leading up to retirement or in the early years of retirement can have destructive long-term effects.  Understanding the potential scenarios along with proactive planning and sensible strategies for mitigating the impacts are paramount to long-term success.  

Monte Carlo and Retirement Success

  • What's the likelihood that your retirement assets will allow you to maintain your lifestyle in retirement?
  • What rate of return do you need to earn in retirement to maintain your lifestyle?
  • What asset allocation is consistent with your need to generate retirement income while providing growth to protect your future purchasing power?
  • When is the optimal time for you to start Social Security?

The average person works 80-90 thousand hours in their lifetime, but spends less than 10 hours planning for their retirement. That seems unbelievable, but it is true. Monte Carlo analysis is a detailed way to test the probability that your retirement assets will last the rest of your life while maintaining your lifestyle. Key factors in this analysis are your income sources, expenses, rate of inflation, life expectancy, and the expected long-term return for your investments. Some of these factors are controllable or dependable like expenditures and Social Security while others can be forecast with some level of confidence. 

Income in retirement usually consists of Social Security and retirement account distributions although pensions still exist for some people.  Social Security can start as early as 62, but the full retirement age is currently around 67. If Social Security is taken before 67 you will receive a discounted payment while delaying your payments will increase your benefits. Generally speaking, you would need to live until age 82 or 83 to justify delaying your Social Security benefits to age 70.    

SS breakeven

For most retirees distributions from retirement accounts (IRA’s, 401k, 403b) will serve as another major source of income.  Investing your retirement accounts to produce income while providing growth to protect your future purchasing power requires a properly diversified portfolio that is structured to meet BOTH objectives.  Tactical rebalancing of your portfolio to control risk and capture profits to fund distributions will also play an important role in determining your long-term viability.  Required Minimum Distributions (RMD’s) from retirement accounts (ROTH IRA’s are the exception) are currently required by law beginning at age 70 ½. Current legislation called the SECURE Act could increase the age to 72. 

Your expenditures/withdrawal rate are the most controllable portion of this analysis and can have a significant impact on the probability that your money will last the rest of your life. Inflation and life expectancy are uncontrollable variables that can still be forecast with some level of confidence. See http://www.vonholt-fa.com/our-blog/51-risks-retirees-face.html for a further explanation of these topics.

How Monte Carlo works

Fixed income sources such as Social Security and pensions can be forecast with a high degree of confidence.  A strong understanding of past spending patterns and forecasts of non-recurring expenses such as travel or renovations are the only variables that are under your direct control.  An assumption with regards to longevity should be conservative rather than using an average so that you do not outlive your assets. Long-term forecasts for inflation and rates of return can be made with a fairly high degree of certainty although the sequence and variability can substantially impact your chances for success.  

To address the concerns about the sequence and variability of inflation and rates of return a Monte Carlo simulation should be completed. Monte Carlo attempts to show what might happen in a situation where inflation varies and the returns on assets are positive in some years and negative in others. The simulation runs 10,000 iterations through life expectancy to test the sequence and variability of inflation and returns to provide an average outcome and the probability of maintaining your lifestyle through certain ages. 

Below is an example of a Monte Carlo simulation which shows a client’s probability of living their desired lifestyle to certain ages. Monte Carlo analysis should be updated to reflect material changes in your life situation or goals and can include multiple alternatives. 

Monte carlo

Anyone less than 10 years from expected retirement should complete this type of analysis and understand the impact key variables may have on their chances for a financially successful retirement. This analysis is a good way to start the process of retirement planning to ensure that a lifetime of work leads to a long and comfortable retirement.

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