Here’s the second part of a three-part post to answer the nitty-gritty details of the following question:
If you’re receiving a military pension, then how should you invest the rest of your portfolio?
One noted economist compares an investor’s portfolio against their lifetime income. Moshe Milevsky’s book “Are You A Stock or A Bond?” describes the “human capital” of lifetime earnings and pensions. Although savings are important to retirement, the size of an investment portfolio may be a minority of a retiree’s net worth when compared to their lifetime earnings power and their pension income.
Servicemembers and retired veterans, with their stable incomes and high-quality inflation-fighting pensions, have a particularly high human capital.
“Human capital” is also a good perspective on a military career. Veterans tend to be paid less than their civilian counterparts (while getting shot at more often), but their likelihood of continued employment is much higher. Milevsky’s book uses the examples of university professors and Wall Street stockbrokers. Professors make far less each year but (with tenure) can look forward to a lifetime of paychecks. Stockbrokers may earn millions in one year but could be unemployed the very next morning. Their high-dollar earnings power has no guarantee of continued employment. The challenge for both occupations is to manage their assets to be supported by their lifetime earnings, no matter how low or uneven their income may be.
Human capital is a relatively new concept and not yet widely accepted. Most financial analysts and website calculators ignore human capital by treating salaries and pensions as “just” a stream of income. Human capital’s impact is not considered on a portfolio’s overall asset allocation.
Military retention is another impact of human capital. At some point every one of 1.4 million veterans (and their 1.9 million family members) has to decide whether to stay on active duty or to continue drilling in the Reserves/National Guard. Only 15% of the military’s members reach 20 years. A pension is not the only reason to stay on active duty, but it would certainly help people endure long, dangerous deployments or stressful midwatches. The military may be a familiar lifestyle with a guaranteed paycheck, but is it worth the pain? If “human capital” could compare the earnings of active duty to the Reserves/NG, or assess the impact of completely quitting the military, then the analysis could bring financial logic to an intimidating lifestyle decision.
“Net worth” doesn’t account for cash flows like pensions or Social Security, so their income has to be included as their lump-sum equivalent. A convenient assumption about inflation-adjusted pensions is that their payout is constant in today’s dollars– they maintain their buying power for the rest of the retiree’s life.
Reserve/National Guard pensions and Social Security are more complicated because their payouts start later. However Congress and the Department of Defense attempt to improve retention by raising military pay at least as fast as inflation, while promotions and longevity pay keep servicemembers ahead of inflation. It’s conservative to assume that future pay dollars will have the same buying power as today’s dollars. The Social Security website’s benefits calculator also produces its results in today’s dollars, and benefits are adjusted for inflation. That means Reserve/NG pensions and Social Security are paid in inflation-adjusted “today” dollars through the rest of a life expectancy.
The lump-sum discounting math is more complicated for military pensions with survivor benefits and for civilian defined-benefit pensions without inflation adjustments. Military retirement calculators can give an estimate of the lump-sum value of survivor benefits. Civilian corporations estimate their pension calculations on an actuarial analysis of lump-sum value, and labor unions offer their own analyses.
Once projected pensions and Social Security benefits have been converted from income streams to lump sums, they should be included in a veteran’s net worth. Investment portfolios would be added at their current value, as well as homes or rental real estate. Personal property (such as vehicles, furniture, recreational equipment, and clothing) can also be included. Mortgages, vehicle loans, and other debts are subtracted to get the total net worth.
The results can be startling.
Tomorrow: adjusting a retirement portfolio’s asset allocation for a military pension
Asset allocation considerations for a military pension (part 1 of 3)
“Present value” estimate of a military pension
Saving base pay and promotion raises
Military pension inflation protection
Tailor your investments to your military pay and your pension
Where to put your savings while you’re in the military
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I retired in 2002 after 20 years in the Navy's submarine force. I wrote "The Military Guide to Financial Independence and Retirement" to share the stories of over 50 other financially independent servicemembers and veterans.