10

Got a defined benefit pension plan? Consider yourself lucky then consider it a big bond

You’ve probably heard that risk and reward go hand-in-hand.  Take on more investment risk and you might be rewarded with higher investment returns.  The potential for higher investment return is the carrot dangled in front of us for owning the risky investment.

Understanding some asset classes have more risk than others, investors often balance their portfolios, balancing primarily between stocks and bonds.  What’s the best mix for stocks and bonds?  There isn’t one (that I know of) but after some brief research courtesy of Vanguard’s website, I found out what someone might expect from their investment returns if they held the following mixtures of stocks and bonds for many decades based on historical data.

 

Vanguard Balanced Portfolios:

Vanguard Growth Portfolios:

Based on my investor profile (growth-oriented) my investment plan calls for an allocation of about 70% stocks and 30% bonds respectively.  Actually, I’m probably much more conservative than that.  This is because I contribute to a defined benefit pension plan at work which I consider a big bond in my portfolio.

I am very fortunate to have my defined benefit (DB) plan which makes the amounts paid out from the plan at the time of retirement known.  Contrast this to another type of pension plan, a defined contribution (DC) plan, which makes the amounts contributed to the plan until retirement known.  This distinction between a DB and DC plan is very important and it’s defined a few times over in a great book entitled Pensionize Your Nest Egg by Moshe Milevsky and Alexandra Macqueen.  Since a DB plan is a binding contract that provides guaranteed income in retirement, it’s very bond-like in my opinion.  Although valuable, DC plans on the other hand offer no guaranteed benefit at retirement; they are tax-sheltered investment plans that offer no promises of lifetime income.

For as long as I participate in the big bond pension plan I’m going to take on more equity risk; building my personal portfolio with equities.  There will be much more volatility focusing on equities (over bonds) in my investing future but I’m comfortable with this risk and it works for me right now.  You might not feel the same when your portfolio has the potential to drop 30% or more like it did only a few years ago.

Personal finance has “personal” attached to it for a reason so all investors are encouraged to consider identifying their own risk-and-reward comfort levels, pensions or no pensions as part of a comprehensive financial plan.  Understanding your risk profile and knowing some asset classes have more risk than others should help you design your financial plan for a successful retirement journey.

If you have a defined benefit pension plan, do you view it the same way I do?

If you have a defined contribution pension plan, are you more risk adverse because of it?

Filed in: Asset Allocation, Pensions

10 Responses to "Got a defined benefit pension plan? Consider yourself lucky then consider it a big bond"

  1. SeekingTruth says:

    Ibbotson, the asset allocation master, did a ~32 year (1972-2004) back-tested analysis which showed having 7-16% of precious metals (SPMI) in your portfolio:
    i) lowered volatility and risk (by a max of 6%), and
    ii) increased the over-all return of the portfolio (to a max of +4.5%)

    Of course, knowing the prices of precious metals have gone up quite substantially since 2004, the returns have only increased.

  2. We are very lucky too as both my husband and I have a defined benefit pension. If we can keep the jobs we are in until we are retired we will be set. Between our pension and our other savings we will be able to retire quite comfortably.

  3. I just recently was enrolled in a DBPP and I am very thankful! It allows me to focus more on paying off my mortgage rather then just saving for retirement.

  4. mtddc99 says:

    Although I agree that DB pension plans are generally a good thing to have there are, in my opinion, still a few warts on them. I am self employed but my wife works in the Ontario college system and has a DB plan that is funded 50/50 between herself and her employer. Although her payout at retirement is defined by a set formula, her level of contribution is NOT permanently set. When she began her job 5 years ago her contribution level was about 8% of her salary. That number has increased every year since to the point that in 2013 she will be contributing about 12.5% of her salary to her DB plan. This means that she will be contributing 56% MORE to her DB plan next year (compared to year 1) – for the EXACT same payout at retirement! The pension fund has underperformed and to make this up has simply increased the level of contributions. Next year my wife will contribute approximately $11500 to her pension and that amount will be matched by her employer. Looking at those contribution amounts and seeing the resulting payout leads me to wonder how efficiently that money truly is being invested.

  5. It’s funny that some people with defined benefit plans don’t realize how lucky they are or they don’t know what they are. We don’t have the defined plan so we have to plan our investments and retirement out and hope for the best although sometimes it can get disheartening. Mr.CBB

  6. SeekingTruth says:

    @mtddc99

    Similar experience.
    I work for the the BC provincial government; year one I received a letter informing me of my pension details and how I (and others) would not have our contributions raised. Less than one year later I received another letter informing me (and others, I presume) that my contribution rate would now be increased due to lack of fund performance during the early 2000’s. My contribution rate has increased ~2%/yr. Keeping up with inflation, I guess. But why send out such an ignorant letter in the first place?

    As for my DB plan, it will work out great for me (unless drastic pension changes occur before I retire). I would have to net 14% annually doing my own investing in order to get the same pay-out my pension will provide.

  7. Michel says:

    My wife and I are retired and get a pension from the Ontario Teachers’ Plan. I consider this the bond portion of our overall portfolio. Without going overboard with risk/reward, I can therefore invest in good blue chip dividend paying companies and sleep at night. What do you think?

    • Personally, I feel this way for my portfolio. The DB plan is a big bond, I can take a bit more risk some blue-chip companies, although it’s not a HUGE risk for me to own a few Canadian bank stocks, pipelines, telcos and energy companies. I index everything else. Pretty simple portfolio for me actually.

      You’re going to have a great retirement with two OTPPs! You’ve earned it.

Leave a Reply

Submit Comment
*

Top of Page

Copyright © 2009 to 2014 by My Own Advisor. All Rights Reserved. Admin
Powered by Theme Junkie  •  Designed by Dividend Ninja