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?