How to Use Social Security in the Allocation of Investments

Many investment allocation models look at stocks, bonds and cash. They don't take Social Security into account, even though Social Security can play a role in an overall investment plan, especially since it provides a relatively stable string of regular income. How you weight it, though, is a matter of your own personal strategy.

How Social Security Works

Social Security works much like an annuity. Throughout your working life, you and your employer, if you had one, pay into the Social Security system. When you reach retirement age, you receive a set monthly payment that increases every year along with the cost of living. The income is generally tied to your life expectancy and is guaranteed by the government.

Valuing Social Security

If you look at Social Security as an income stream, you can value it relative to other investments. For instance, if you receive $20,000 per year in Social Security, it's similar to having a lifetime inflation-indexed annuity that pays $20,000 per year. Since it works similarly, you can compare the two values. For instance, if annuities pay 4 percent per year, a $20,000 income stream would cost $500,000, making your Social Security income roughly equivalent to having $500,000 of investments.

Social Security vs. Fixed Income

Since Social Security can serve the same purpose, to some extent, as a fixed income investment like some annuities or like bonds, it could be included as a part of your allocation for those investments. Famed investor John Bogle, founder of the Vanguard Group, has argued this in the past. By taking this attitude, you would choose to allocate relatively more money toward stocks and less toward bonds or other fixed income investments, as a portion of your fixed investment allocation would already be covered by your Social Security.

Ignoring Social Security

Social Security and a fixed income asset, such as a bond, have a fundamental difference. When you have a bond, you have an investment with value that you can sell or leave to an heir. Social Security, on the other hand, goes away when you die, other than some minimal benefits for your survivor. In addition, if you treat Social Security as a part of your portfolio and choose to purchase more stock and fewer bonds, your overall portfolio could become riskier and your income could drop if the market suffers.