1/n Social Security, Target Date Funds & Asset Allocation: A Thread (this is for you @jasonzweigwsj ):
@jasonzweigwsj 2/n Let's start with some assumptions: 1) The average Social Security claiming age is 65 2) The average social security payment is about $18,000 per year 3) Average life expectancy of a 65 year old is 19 years.
@jasonzweigwsj 3/n This stream of inflation adjusted payments is worth something financially and it looks a lot like a bond, so we are going to determine what these payments would be worth if you had to create a portfolio of bonds to replicate (we are going to find the present value).
@jasonzweigwsj 4/n Given that the payer (the US Government) is considered risk free (yeah, I know) and that the payments are adjusted for inflation (not CPI but let's pretend) then the correct discount rate would be the rate on a 20 year TIPS bond or about 0.25%.
@jasonzweigwsj 5/ Given that the current interest rate on a 20 Year TIPS is 0.25% that would put the present value (PV) of those payments at a value to the individual at about $333,600.
@jasonzweigwsj 6/ Let's say that this individual has been lucky enough to save $500,000 into a 401k by age 65 and has been using a target date retirement fund and will continue to use a target date retirement fund. At age 65 the asset allocation is probably close to 50% in stocks and 50% bonds
@jasonzweigwsj 7/ However, by age 70 or so, most target date funds would have an asset allocation that is about 30% stocks and about 70% bonds and maintains this asset allocation for the rest of the life of the fund.
@jasonzweigwsj 8/ I think there are a couple of very large problems with this: 1) the 4% withdrawal rule that everyone likes to site assumes that the asset allocation is 50% stocks and 50% bonds through the WHOLE period and doesn't change!
@jasonzweigwsj 9/ When using a target date fund glidepath and even assuming historical returns and risk the withdrawal rate decreases closer to 3% not 4% and it is solely due to becoming and staying more conservative over time.
@jasonzweigwsj 10/ The second problem is that looking holistically at this person's financial life, they have a "portfolio" that is about $833,600 value - $333,600 of Social Security benefits and $500,000 of financial capital.
@jasonzweigwsj 11/ At age 65, their total "portfolio" asset allocation is actually 70% in bonds (social security + bond allocation in target date fund) and by age 70 its closer to 82% in bonds (assuming no price changes).
@jasonzweigwsj 12/ To sustain portfolio buying power and to hedge against a longer than expected life, the 30% stock allocation in the target date fund is probably too conservative is it causes the effective asset allocation for the whole "portfolio" to be closer to 80% in bonds.
@jasonzweigwsj 13/ In addition, the longer someone lives the more the social security present value is worth and the larger the effective allocation to bonds...this also says nothing of the spend rate in the 401k and that it is using more of the equity portion of the portfolio for spending.
@jasonzweigwsj Fin/ I think target date funds are a great creation (especially how people seem to behave well when using them) but I see this asset allocation glidepath used and how it interacts with Social Security as being one of their biggest flaws.
