PLANSPONSOR - October/November 2018 - 20

Figure 3: Optimal equity allocation vs. starting wealth
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AUTHORS
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Figure 3: Optimal equity allocation vs. starting wealth
REAL WORLD CONSIDERATIONS: THE STOCK-BOND ALLOCATION
Income for the Retirement Years:
Optimizing the Main Decisions
in Retirement
Figure 3 shows the relationship between the optimal equity
allocation and the starting savings balance. To be consistent with
Savings at retirement
Steve Sapra
Executive Vice President
Client Solutions and Analytics
Ying Gao
Vice President
Client Solutions and Analytics
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Savings at retirement
Figure 4: Optimal equity allocation vs. Social Security
default rate
Figure 4: Optimal equity allocation vs. Social Security
default rate
Financial advisors and their clients planning for
retirement must navigate a set of intricate and
interrelated decisions. When's the best age to start
taking Social Security benefits? How should assets
be allocated? Does an annuity make sense? These
decisions are complicated enough in isolation.
But when they're addressed together, they grow
exponentially more complex.
It's important to consider how the optimal asset allocation changes
as a function of one's wealth, and one's confidence in the viability of
the Social Security system.
REAL WORLD CONSIDERATIONS: THE STOCK-BOND ALLOCATION
It's important to consider how the optimal asset allocation changes
as a function of one's wealth, and one's confidence in the v ability of
the Social Security system.
Figure 3 shows the relationship between the optimal equity
allocation and the s arting savings balance. To be consistent with
real world behavior and data, we assume that the investor has a
Social Security benefit comparable to someone who earned an
average real wage of $56,000 through their working careers, takes
their Social Security benefit at age 65, and does not invest in an
annuity (either immediate or deferred). As before, we set the wealth
constraint to 75% of its starting value.
real world behavior and data, we assume that the investor has a
Social Security benefit comparable to someone who earned an
average real wage of $56,000 through their working ca eers, takes
their Social Security benefit at age 65, and does not invest in an
annuity (either immediate or def rred). As before, we set the wealth
constraint to 75% of its s arting value.
Investors with low wealth, based on our model, will want to allocate
significantly to equities to counterbalance their bond-like Social
Security benefit. At the other end of the wealth spectrum, the equity
allocation levels off at around 30%. Beyond $2 million in assets, we
find that the optimal allocation to equities slowly declines, but
remains close to 30%. These results assume that the retiree's Social
Security benefit remains unfettered.
Investors with low wealth, based on our model, will want to allocate
significantly to equities to counterbalance their bond-like Social
Security benefit. At the other end of the wealth spectrum, the equity
allocation levels off at around 30%. Beyond $2 million in assets, we
find that the optimal allocation to equities slowly declines, but
remains close to 30%. These results assume that the retiree's Social
Security benefit remains unfettered.
Of course, there is no guarantee that Social Security will continue in
its current state. Therefore we modify our model to allow for a
potential cessation of one's Social Security benefit by assuming a
particular default rate for Social Security and then re-computing the
stock-bond allocation. We assume the same parameter values in the
previous analysis and an investment portfolio balance of $385,000.9
Social Security default hazard rate (%)
Social Security default hazard rate (%)
Hypothetical example for illustrative purposes only. The model output included
here is not based on any particularized financial situation, or need, and is not intended
to be, and should not be construed as a forecast, research, investment advice or a
recommendation for any specific PIMCO or other strategy, product or service. PIMCO
does not offer insurance guaranteed products or products that offer investments
containing both securities and insurance features. The model is limited to analyzing the
optimal retirement income stream. Investors should speak to their financial advisors
regarding the investment mix that may be right for them based on their financial
situation and investment objectives.
Source: PIMCO and the Social Security Administration as of 31 December 2017
Hypothetical example for illustrative purposes only. The model output included
here is not based on any particularized financial situation, or need, and is not intended
to be, and should not be construed as a forecast, research, investment advice or a
recommendation for any specific PIMCO or other strategy, product or service. PIMCO
does not offer insurance guaranteed products or products that offer investments
containing both securities and insurance features. The model is limited to analyzing the
optimal retirement income stream. Investors should speak to their financial advisors
regarding the investment mix that may be right for them based on their financial
situation and investment objectives.
Source: PIMCO and the Social Security Administration as of 31 December 2017
Complications arise because each decision affects the others. The chosen asset allocation at
retirement, for instance, affects both the level and sustainability of income generated by their
investment portfolios. Social Security can be an excellent hedge against longevity risk, but delaying
benefits means a larger fraction of a client's investment portfolio may be needed for consumption in
the intervening years. This, in turn, may affect the asset allocation and whether to buy an annuity.
We provide a framework for answering these questions collectively. Our model seeks to optimize
decisions by aiming to generate the most stable and consistent income stream possible for a given
retiree's wealth and Social Security income. We illustrate the interrelationships among these
decisions in two hypothetical case studies - one for an individual with moderate income and low
wealth, and one for someone with high income and high wealth.
Based on our model, we conclude that the mix of stocks and bonds one should hold at retirement
depends significantly on an individual's level of wealth and that the decision to annuitize is
relatively consistent across the wealth spectrum, albeit with differing allocations.
For additional details on methods and results, please see our In Depth article, " Income for the
Retirement Years: A New Model for Seeking Stable Retirement Income. "
Figure 4 shows that even a modest expectation of default
dramatically reduces the equity allocation. For example, the equity
allocation falls from 53% to 34% for a 0% and 5% default intensity,
respectively. This result highlights how important the perception of
Social Security's solvency is to the asset allocation decision. If one
anticipates even a slight chance of default, the optimal equity
allocation falls dramatically. When one sees Social Security's survival
as highly unlikely, our results show that the equity allocation falls to
as low as 20% for all investors.
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CONCLUSION
Let's examine the key decisions:
SOCIAL SECURITY
CONCLUSION
Our model provides a framework that seeks to solve collectively
for the optimal choices for Social Security deferral, annuitization,
asset allocation and consumption. We show that these decisions
depend critically on retirees' level of savings, their Social Security
benefit, and the confidence they have in their Social Security
benefit remaining uninterrupted. While there is no single solution
for all situations, our framework allows us to put forth concepts
that may help solve for determining the most consistent
retirement income stream one can obtain given starting
conditions and drawdown preferences.
Social Security benefits retirees not only by providing a stable income stream, but also by hedging
both inflation and longevity risk. Recipients can initiate benefits between age 62 and 70. Starting
earlier provides immediate income but delaying from age 65 to 70 boosts benefits payments by 43%.
The models, scenarios and decisions included here are not based on any particular financial situation, or need, and are not
intended to be, and should not be construed as a forecast, research, investment advice or a recommendation for any specific
PIMCO or other strategy, product or service. Individuals should consult with their own financial advisors to determine the most
appropriate allocations for their financial situation, including their investment objectives, time frame, risk tolerance, savings and
other investments. Investors should speak to their financial advisors regarding the investment mix that may be right for them
based on their financial situation and investment objectives.
SPONSORED SECTION
SPONSORED SECTION
Our model provides a framework that seeks to solve collectively
for the optimal choices for Social Security deferral, annuitization,
asset allocation and consumption. We show that these decisions
depend critically on retirees' level of savings, their Social Security
benefit, and the confidence they have in their Social Security
benefit remaining uninterrupted. While there is no single solution
for all situations, our framework allows us to put forth concepts
that may help solve for determining the most consistent
retirement income stream one can obtain given s arting
conditions and drawdown preferences.
as low as 20% for all investors.
Of course, there is no guarantee that Social Security will continue in
its current state. Therefore we modify our model to allow for a
po ential cessation of one's Social Security benefit by assuming a
particular default rate for Social Security and then re-computing the
stock-bond allocation. We assume the same parameter values in the
previous analysis and an investment portfolio balance of $385,000.9
Figure 4 shows that even a modest expectation of default
dramatically reduces the equity allocation. For example, the equity
allocation falls from 53% to 34% for a 0% and 5% default intensity,
respectively. This result highlights how important the perception of
Social Security's solvency is to the asset allocation decision. If one
anticipates even a slight chance of default, the optimal equity
allocation falls dramatically. Whe one ees Social Security's survival
as highly unlikely, our results show that the equity allocation falls to
Optimal equity allocation (%)
Optimal equity allocation (%)
Optimal equity allocation (%)
Optimal equity allocation (%)
$30,000
$100,000
$175,000
$250,000
$385,000
$500,000
$600,000
$1,000,000
$1,500,000
$2,000,000
$30,000
$100,000
$175,000
$250,000
$385,000
$500,000
$600,000
$1,000,000
$1,500,000
$2,000,000

PLANSPONSOR - October/November 2018

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