Advanced Asset Allocation: Should I Treat a Pension Like a Bond?

Most of us are investing with the goal of a happy, secure retirement -- but figuring out the right level of security is no picnic. A portfolio that's too aggressive leaves you exposed to risk in a downturn. One that's too conservative will sacrifice returns on investment, and could mean you come up short later in your senior years. It's a balancing act that has led to an interesting question from Motley Fool Answers listener Chuck, who, unlike the majority of private sector workers, has a couple of pensions he'll be able to rely on to supply some of his financial needs in retirement. But how should he factor those funds into his asset allocation calculations? In this segment from the July mailbag show, hosts Alison Southwick and Robert Brokamp, along with special guest Ross Anderson, a certified financial planner at Motley Fool Wealth Management -- a sister company of The Motley Fool -- weigh in on the nuances.

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This video was recorded on July 30, 2019.

Alidon Southwick: The next question comes from Chuck. "I am 61 years old, retired, and receiving a pension from both the Federal government and the military. My wife and I have significant amounts in IRAs, a 401(k), and the Federal Thrift Savings Plan. We also own commercial real estate in San Francisco and an annuity that pays me until I turn 69 and a half, just in time for Social Security, which will be twice the amount of the annuity. The income from the pensions, real estate, and annuity is enough to make our living expenses.

"My question is when determining how to allocate our portfolio between stocks and bonds, can we consider the pension as equivalent to a very safe bond or long-term annuity? If so, should we feel relatively safe allocating everything in our IRA, TSP, 401(k), and brokerage account to stock?"

Ross Anderson: Chuck, I appreciate the question. I appreciate your military service. It sounds like you put yourself and your family into a really great position. When you've got enough income coming in from essentially guaranteed sources or sources that are very stable, you can really choose to treat the investments however you'd like.

Now, I don't think of a pension identical to a bond in the sense that you can't rebalance out of it. If you thought of yourself as being the kind of guy that would have had a 60/40 portfolio or even an 80/20 -- meaning 80% stocks and 20% bonds -- that pension isn't a replacement for the bond because if the market has a crash you can't sell the pension and buy more stocks, so you've lost the ability to rebalance.

But in terms of the amount of risk and volatility that you can accept, it's really up to your own stomach acid, because at this point it doesn't sound like you're relying on a distribution from the portfolio assets to support your lifestyle. At that point, it really becomes a determination of how comfortable are you with risk? What are your goals in terms of growth on those assets? If you want to be all in stocks, I think you can afford to be.

Robert Brokamp: I would say the same thing. Now obviously his situation is that he has a very secure pension. With the federal government and the military he's going to be fine. I'll just say to anyone else out there, you want to make sure that you have a safe pension before you go all in on that and have everything else in the stock market.

Anderson: The way I think about it is we're going to look at your portfolio and ask, "How much do we need to take from the portfolio on an annual basis to support your lifestyle?" For some people, if they don't have any pension assets and it's purely Social Security, for example, we might be needing to take that 4-5% withdrawal rate, and so the amount that they're going to need to protect if there's a market downturn is going to be at least three to five years of that amount.

So a 25% bond allocation might mean that you can go through a four or five-year drought in the stock market. The less that you're relying on the portfolio and the more pension income you have covering those needs you can be a little bit more flexible with how aggressive you get.

Brokamp: And Chuck, if you're looking for someone else who agrees with you -- and this actually touches on Jonathan's question about bonds -- The Globe and Mail recently interviewed Harry Markowitz, who is the Nobel Prize-winning father of Modern Portfolio Theory [MPT]. He's almost 92 years old. They asked him how he is investing these days and he said, "I own very few bonds because I've got my teacher's pension, I've got my Social Security, and frankly I have enough in the stock market so that even if it drops I still have plenty of money." So he has very little in bonds and he's not going to be interested in bonds until they get to at least 4%.

The other aspect I would add about that is that he's almost 92 and he's still working. He's still writing books, he's still consulting, he's still on the faculty at UC San Diego, so that's a whole other aspect for him. He's got his situation taken care of.

Anderson: That's always my favorite Buffett fact. People want to invest like Warren Buffett and I'm like, "Do you realize he's in his 80s and still working?" That's the first thing to growing your wealth by a lot...

Brokamp: Yes, that's true.

Anderson: ... is that you don't stop at 65.