Consider two investors, Allan and Bob. They both retire at age 62. They’re both unmarried. They each have $40,000 of annual expenses and a portfolio of $650,000. And, if they claim Social Security at their full retirement age of 66, they’d each receive an annual benefit of $20,000.
The only difference between the two is that Allan decides to claim Social Security ASAP at age 62, while Bob decides to wait all the way until age 70. As a result:
- Allan will be receiving $15,000 of Social Security per year (starting at age 62), and
- Bob will be receiving $26,400 of Social Security per year (starting at age 70).
How should this difference affect the choice of asset allocation for their portfolios?
Stocking up on Cash (or CDs, or Short-Term Bonds)
Allan will have to satisfy $25,000 of (inflation-adjusted) expenses each year from age 62 onward, because he’s getting $15,000 of Social Security per year. In contrast, Bob will have to satisfy $40,000 of expenses for 8 years (because he isn’t yet receiving any Social Security), then just $13,600 per year for the remainder of his life.
Because Bob is going to be spending down his portfolio at a fairly rapid rate during those first 8 years, I think it makes sense for Bob to have a significant amount of holdings that can be relied upon not to experience large losses during those 8 years.
If I were in Bob’s situation, I’d want enough super-safe holdings to satisfy the additional (temporary) shortfall that comes from holding off on claiming benefits. For example, I might create a CD (or bond) ladder with a $26,400 CD maturing each year for 8 years.
What’s the Point of Having Extra Safe Assets?
One of the challenges of delaying Social Security until 70 is seeing your portfolio decline dramatically in the pre-Social-Security retirement years.
By designating specific assets for the extra spending during those years, you can make it mentally easier on yourself. You’ll know ahead of time that the plan is for those assets to be spent, so it’s not scary when you see that that’s exactly what’s happening. (In addition, it makes it easier to assess how well the rest of your portfolio — the part that’s intended to rest for the rest of your life — is doing.)
What to Do with the Rest of the Portfolio?
The remainder of Bob’s portfolio — so, somewhere in the range of $438,800 (i.e., $650,000 minus 8 x $26,400) — should probably look roughly the same as Allan’s portfolio. In each case, the point of the portfolio is to satisfy a relatively steady level of spending, starting at age 62 and lasting for the remainder of the investor’s life.
In other words, this money can be invested in keeping with the conventional wisdom for a retirement portfolio: build a diversified portfolio with some sort of middle-of-the-road asset allocation, using low-cost mutual funds or ETFs.