Most people don’t get a pension. In fact, only around 20% of Americans do. If you are among them, you’re in an enviable position when it comes to your retirement security. And that’s not just because your pension likely provides guaranteed income for life.
The existence of that pension money also impacts what you can do with your retirement portfolio. In fact, because you have this guaranteed source of income, you may be able to invest your retirement portfolio more aggressively. This makes your invested money work a lot harder.
Of course, most people don’t get this opportunity. So, if you do, it’s worth taking a close look at the math to understand the details.
How a pension allows you to put your portfolio to work
Retirees often prefer a fairly conservative investment portfolio because they can’t risk having too much money in stocks. They’ll need to rely on their portfolio for steady income, so if the stock market crashes at the wrong time, they could end up selling when their investments are down. This would lock in losses and make it harder to maintain the account balance necessary to earn enough returns to make their money last throughout retirement.
Now, sequence of return risk still exists if you have a pension, but your guaranteed income source reduces the risk. You simply won’t need to rely on your investments as much when you have money coming in each month. If you get a $2,000 pension and collect the average $2,071 monthly Social Security check, that’s $4,071 per month to live on before you touch any assets.
Depending on your spending needs, you may only need to generate an additional $1,000 to $1,500 in monthly supplemental income, while someone without a pension might need closer to $3,500 to $5,000 to add to their Social Security check.
If you can afford to withdraw less and you aren’t as dependent on your investments to provide income for basic expenses, this gives you more room to invest for long-term growth rather than stability. Rather than, say, a 60/40 bond split that might be appropriate for many older investors, you can put more of your money into equities and give yourself the chance to earn returns that a typical retirement portfolio wouldn’t be able to achieve.
Your pension essentially acts like a bond that doesn’t mature, filling the role of bonds in a traditional portfolio and offering you a buffer against market volatility that enables you to take on far more risk. In fact, if you treat your pension as a fixed-income annuity, you can use a simplified perpetuity-style estimate (which assumes lifetime payments similar to a bond that never matures) to evaluate your pension as a bond equivalent: Present value = (Annual pension benefit) / Discount rate (bond yield). If your pension pays $24,000 per year and you use a conservative 3% discount rate, you’d find you need around $800,000 in bonds yielding 3% to generate the same income.
How does the math work if you have a pension?
So, how does the math work if you hold a pension and can build your portfolio around growth rather than stability? Let’s take a look at what a sample portfolio might look like
- 50% in the Vanguard Total Stock Market ETF (VTI), which provides broad exposure to the U.S. market
- 20% in Vanguard Growth ETF (VUG), which is focused on large-cap growth stocks primarily in tech and healthcare
- 20% in Invesco QQQ Trust (QQQ), which tracks the Nasdaq 100 index
- 10% in Vanguard Total International Stocks ETF (VXUS)
With this portfolio, you could expect around 9% to 12% long-term annualized returns based on historical performance, although most projections for future returns are in the 6%–8% range. By comparison, if you invested for stability in a traditional 60/40 bond split, you might put 60% of your assets into VTI and 40% into the Vanguard Total Bond Market ETF (BND), which you could expect to provide average annual returns somewhere in the 6.5% to 7.5% range based on historical performance or around 4.5%–6.5% based on projected future returns.
The difference in likely future returns is obviously substantial, especially when working with a large retirement investment portfolio. So, it’s worth considering whether your pension can allow you to invest more aggressively and make your portfolio work harder for you. A financial advisor can help you to decide on an asset allocation that makes sense given your pension amount and future goals, so you can make sure you’re maximizing the advantages your pension provides.
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