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Discussion Starter #1
I raised this issue before but didn't get much response. I would like to try again. For those professional planners out there: when you consult with your clients about an appropriate asset mix do you take the fact that they may have a pension into account? I am familiar with the concept of efficient return/risk but it seems to me that in retirement the receipt of a pension (fixed income stream) should skew the allocation of the retirement portfolio towards equities. Do any of you take this into account with your clients and if so how? Haven't seen anything relating to this in print. Always apprecite the thoughtful responses I get here. Thanks in advance.
 

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My spouse has a defined-benefit pension from the government. Therefore, our retirement portfolio is more aggressive with a higher allocation to equities. I totally agree that if one has a DB plan (esp. from the Govt), the retirement portfolio should be tilted more towards equities.
 

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Yeah, I co-wrote a book about it (see sig line, below); and I am spending the next few weeks editing videos on this exact topic.

For a detailed (theoretical) look at how pensions can impact sustainable withdrawal rates in retirement, you could also read this recent Milevsky and Huang paper, forthcoming from the Journal of Financial Planning - "Spending Retirement on Planet Vulcan."

p.s. I hold the Certified Financial Planner designation but I do not work as a financial planner providing advice to individuals.
 

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Discussion Starter #5 (Edited)
MG-I read the article. Fascinating. Clearly they (and you I presume) are making the argument that pensionizing a portion of one's nest egg can lead to higher spending utility over the remainder of one's life. Also, if one has a pension a higher than usually expected spending rate may be optimal. The authors didn't deal specifically with optimal asset mix though. This seems to one their ToDo list? Tried to order your book but not yet published. Thanks.
 

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It seems like the straight forward answer to your question is that a pension can be valued like any other financial instrument. You can arrive at a rough valuation using some assumptions about discount rate and life expectancy. I'd say a pension from a stable company ought to be discounted at roughly 5 or 6%, perhaps 3 or 4% from a government pension, etc.

At the beginning of retirement, with 30 years life expectancy remaining, a non-indexed pension of $x annually would be worth about 17.3x. I'd say it's fair to treat pension income as bond-like.
 

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Discussion Starter #7
It seems like the straight forward answer to your question is that a pension can be valued like any other financial instrument. You can arrive at a rough valuation using some assumptions about discount rate and life expectancy. I'd say a pension from a stable company ought to be discounted at roughly 5 or 6%, perhaps 3 or 4% from a government pension, etc.

At the beginning of retirement, with 30 years life expectancy remaining, a non-indexed pension of $x annually would be worth about 17.3x. I'd say it's fair to treat pension income as bond-like.
This sounds reasonable. Thanks. On this basis my pension is about 40% of my total "nest egg" Not an unreasonable ratio. It's probably worth more based on the article mentioned above as it reduces my longevity risk. Do planners view it this way?
 

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Wow! Lots to respond to. Great!

You can calculate the actuarial present value (APV) of a pension, whether it is CPP or a DB pension. The discount factor is one element - the longevity calculations are the other main factor.

AndrewF: Careful about using life expectancy, not survival probabilities. Using a static life expectancy number is as problematic as assuming a static rate of return (actually, more problematic, as life expectancy is more variable than stock markets).

W/r/t optimal asset allocation - we don't get deeply into this in the book, but there are "sweet spots" in allocating assets depending on a number of factors, including age, withdrawal rate, gender, % of income that is pensionized, desire for a financial legacy vs. desire for more sustainability of income in retirement, etc. The relationship is surprisingly non-linear. We use a variety of algorithms (not Monte Carlo simulations) to find optimal portfolio allocations (not for readers of the book - that's what the company I work for does among other things).

We are just fine-tuning the online calculator that will (accompany the book and) allow users to play around with scenarios to find optimal results for their desired parameters. I'm also editing a couple of videos which are intended to explain the basic concept of the sustainability-legacy frontier (think of the risk-reward frontier) in more detail. Those videos will be posted on our corporate web site.

The book itself is supposed to be available for ordering at the end of August. I haven't personally held a copy in my own hands yet! However, most of the analytics supporting increased pensionizationTM are set out in the Vulcan paper.
 

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Hey, MG, are you a fellow UW Math grad?

If so, I'm embarrassed to be suggesting such ham handed things as using a life expectancy. I see your point, but in terms of creating a rough valuation, people are more likely to have access to reasonable life expectancies than survival rates.
 

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Not math, but I'm a UW grad; and my office is at the Fields Institute for Math Research. As for your second point - well, that's why we wrote the book! (There's a survival probability table in it.) :D
 

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If you're tailoring to individual situations, you'd probably need conditional survival rates based on more than just gender.

On the other hand, I see some risk in falling in love with nice models. We see what happens when quants use theory in the real world, ignore the assumptions (such as that loan defaults are uncorrelated) and other limitations of the model, and lay waste to the world financial system.
 

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Discussion Starter #12
MG-Excellent responses. I have ordered the book. Sounds like your work has progressed quite a bit ahead of the financial planning community. Not surprising I guess. Given your conclusions I am pleased that I opted for such a large pension. On a pre tax basis it is over 50% of total retirement income. Once the book is out I will spend time deciding whether my current 100% equity allocation on the portfolio is optimal. Thanks.
 

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I do a PV on both my DB pension and my CPP and consider them to be fixed income. As mentioned above, the key variable is your longevity assumption. I used several online calculators and concluded that my 10% to 90% range was 84yo to 101yo with a median of 91yo.

For the purpose of my die-broke spreadsheet, I use 101yo so I am being very conservative! That leaves me with a 10% chance of really dying broke!
 

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Discussion Starter #14
I do a PV on both my DB pension and my CPP and consider them to be fixed income. As mentioned above, the key variable is your longevity assumption. I used several online calculators and concluded that my 10% to 90% range was 84yo to 101yo with a median of 91yo.

For the purpose of my die-broke spreadsheet, I use 101yo so I am being very conservative! That leaves me with a 10% chance of really dying broke!
Interesting but not sure I follow-when you say 10% to 90% does this mean you have a 10% chance of living to 101? Seems pretty high unless you are already pretty advanced in years? Also, once you have valued the pensions as fixed income is your target allocation in the usual 40/60 or 60/40 range?
 

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Depending on your goals/needs, I'd think something more toward 60 to 70% fixed income (including pensions) makes sense for a retired person. For a high net worth individual like sqrt, it depends on whether you want a legacy or not.

This is partly why I have limited sympathy for people who moan that they have to put off their retirement because they portfolio allocation was 80% equities (or even 100%) when the market corrected a few years ahead of their planned retirement date.
 

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60-70% of your required income or 60-70% of your total nest egg?

That is, are you suggesting that 60-70% of a retiree's income stream should be from pensionized sources, or 60-70% of their investable wealth (including APV or CPP as an exception + APV of any DB pensions) should be pensionized?

If it's the second, it is rare that this will be an optimal solution - that is, after a certain tipping point, there is no more sustainability to be gained from pensionizing a larger fraction of your nest egg, while the cost to your expected financial legacy is real.

Hope that makes sense. I should be able to demonstrate this once the online calculator is up. I should probably write a technical note on this as well.
 

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Discussion Starter #17
60-70% of nest egg in fixed income(including pension value) seems too conservative to me? Over time the equity component may rise while the fixed component will decline. I can see how this might require rebalancing over time. But early in retirement I'm more worried about inflation than anything else. Equities protect against inflation. Interesting discussion. Thanks.
 

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Perhaps sqrt, but you can buy inflation protection with real return bonds. Many people take on too much risk in their late earning years or retirement years. If you suffer a drawdown on your portfolio of 40% a year before your planned retirement, you were not managing your risk appropriately. It's never high network individuals that you hear moaning, it's often middle class people who had inappropriate asset class allocations/risk profiles for their needs. If you roll the dice and lose, you get little sympathy from me. It's a part of the game.
 

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Discussion Starter #19
Perhaps sqrt, but you can buy inflation protection with real return bonds. Many people take on too much risk in their late earning years or retirement years. If you suffer a drawdown on your portfolio of 40% a year before your planned retirement, you were not managing your risk appropriately. It's never high network individuals that you hear moaning, it's often middle class people who had inappropriate asset class allocations/risk profiles for their needs. If you roll the dice and lose, you get little sympathy from me. It's a part of the game.
Not sure why you think I would be looking for sympathy and maybe for some people a 70% allocation would be appropriate. I need to cover inflation on both the portfolio returns and the pension as it is not adjusted for COLA. Given my circumstances which require only spending dividends from the portfolio I don,t really understand why I should include fixed income in the portfolio given the generous pension I will be getting. I am very interested in testing this theory so blast away I'm open to criticism.
 

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Maybe I wasn't clear: I'm just expounding on the subject of improper asset allocation--more pointing out why your experience/situation isn't relevant to most Canadians, since you are a HNW individual.
 
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