Asset Allocation: Why You May Not Fit the Mold
As you build your long-term investing knowledge, you'll undoubtedly come across articles discussing risk tolerance. A typical page* has this to say:
To make the asset allocation process easier for clients, many investment companies create a series of model portfolios, each comprising different proportions of asset classes. These portfolios of different proportions satisfy a particular level of investor risk tolerance.
A key assumption that many of these articles make is this: with the exception of a social security benefit (quite common and predictable) and inheritances (wildly variable and unpredictable), the primary source of retirement income comes from a person's long-term investment accounts. 401Ks, IRAs, and possibly some taxable investment accounts. The paradigm is one that assumes a defined-contribution retirement plan, with those contributions captured in the investment accounts.
A key benefit available to career military members is the defined-benefit (vice defined-contribution) military retirement. While this plan (sometimes called a pension) was formerly the "rule" for the mainstream American worker, it is now a lonely exception. As a military member planning on serving a career and capturing this benefit, much of that conventional advice and rules-of-thumb simply aren't good fits because the don't account for that pension.
There are several ways that the pension can be accounted for in a retirement portfolio. The method I'll present is one way to handle it, and it's a rough method at best.
A) Establish assumptions. For purposes of this example, let's assume:
- Retirement age of 42 years-old
- 40 years spent in retirement (a nice way of "lets assume you die at 82")
- Inflation-adjusted pension (military pensions are)
- A pension which pays $30K per year (about an E-8 20-year pre-BRS pension)
B) Do some math. Using these assumptions, we'll calculate the present value of this cash flow stream.
- $30K per year x 40 years = $1.2M* *2017 dollars
C) Analyze your portfolio. Assume the $1.2M is inflation-protected cash sitting in an account - because that's essentially what it is.
- If you've been a very disciplined saver during your career, you might have an investment account of $1M. Let's assume you have only $600K. Still a big chunk!
- Traditional portfolio analysis may only look at your asset allocation considering the $600K, and talk about how it need to be balanced and not be too aggressive.
- With the $1.2M equivalent that's earmarked for you, fully two-thirds of your portfolio is very conservative ($1.2M of your $1.8M total). This allows you to be very aggressive with your remaining $600K and still have a quite conservative portfolio overall.
Almost any advisor can do this analysis for you, and do it far better than my basic example. Key for you is to grasp the concept that the future pension can be treated as a conservative, inflation-protected asset. Not entirely unlike the TSP G Fund. This huge pension benefit - and its rarity in American society - is even more reason to closely examine asset allocation to ensure you don't fall into the "safe now - risky later" trap discussed in the Being Too Careful Can Be Very Dangerous post.
Now is the time to take the risk, and - for career military folks - the generous retirement benefit means you can likely handle far more risk than you think.