Tailor Your Investments to Your Military Pay and Your Pension

Moshe Milevsky’s book “Are You a Stock or a Bond?” suggests that military on active duty can invest much more aggressively than many civilians. Milevsky’s concept of “human capital” grew out of his studies of investment and retirement plans.

He noted that every worker has the lifetime potential to earn different amounts of money, with varying degrees of reliability and predictability, depending on their potential occupations. Some careers had a high degree of continuous employment and steady income. Civil servants and university professors could all be expected to have relatively steady jobs which, while not paying large salaries, would earn a decent income with good retirement benefits. The modest yet predictable nature of their income was like a bond.

Other occupations, like Wall Street financier or professional sports, could generate huge payoffs in bonuses or options– but their likelihood of employment and the reliability of their income could be volatile. They could be laid off during any recession or a single injury could end their career.

Although they would probably earn a much bigger total than more steadily-employed professions, their income was not predictable and they might even have to arrange for their own retirements with tax-deferred savings and annuities. The wild swings of their employment and their income resembled a penny stock.

A military member’s “human capital” has the potential to earn millions of dollars over the years between school and retirement. With every paycheck, their years of training, skills, and experience are converted to investment dollars plus retirement and healthcare benefits. Even in a combat zone their pay, benefits, and insurance rise to cover the higher possibility of injury or death.  The military’s reliable predictability of employment is the equivalent of a steady stream of high-quality income. It’s as good as a portfolio of government bonds.

When you’re on active duty you’ll enjoy a steady stream of largely predictable income. According to Milevsky, the asset allocation of your investment portfolio can shift to stocks because your human capital already resembles bonds. You’ll still need an emergency fund and you’ll still want to save for specific goals like buying a home, but you don’t need to allocate much money to low-volatility assets like bonds or Treasuries or CDs. As long as you’re on active duty or drilling for Reserves/National Guard pay then you can take extra risks with your investments for an extra 1% of returns.

If you’re saving military paychecks for retirement, or if you’re retired on a military pension, then you can take extra investing risks! The income stream of your pension is based on one of the world’s highest-quality annuities resembling a portfolio of inflation-adjusted bonds or Treasuries.

If you had to buy these bonds to produce the income stream of your pension, it’s possible that their value would be greater the rest of your savings. In that case, the majority of your overall investment portfolio, including both your pension and your other assets, would be its bond component. Offset that bond allocation by investing the rest of your portfolio in larger portions of equities and real estate. The compounded extra return over 20 years will greatly increase your portfolio and speed your retirement.

The challenge of this financial analysis is its emotional turbulence. While your high-equity portfolio will earn a greater long-term return, it has much higher short-term volatility. If you can sleep at night despite a -25% year once a decade, and if you don’t need to convert the assets to cash within five years, then you could invest more aggressively. You could rely on the bond-like income stream of your paycheck or retirement benefits while raising your asset allocation in stocks, including small-cap and international equities, to enjoy greater returns.

If you find that an occasional 25% loss causes you enough emotional stress to consider abandoning your strategy at the worst possible time (despite its long-term rewards) then reduce your asset allocation of equities until the volatility is low enough to live with. Everyone swears that they’re able to tolerate a high degree of investment volatility, but that’s generally only true during a bull market. No one enjoys downward volatility, and selling equities at the bottom of a bear market will quickly wipe out those earlier years of extra gains.

If you’ve used your Reserve/National Guard career to reach retirement with a smaller pension, or if you retired with no pension at all, then consider using a portion of your savings to buy a no-frills annuity that provides a small percentage of your retirement income. (Milevsky’s book has more details on the types of annuities and their expenses.)

Annuities earned a (deservedly) bad reputation in the 1990s for their high sales commissions and expenses, but even Milevsky has been impressed by their recent improvements. Insurers have learned a lot about estimating their annuity risk, too, and their products are more likely to be backed by a strong company with adequate assets.

An annuity isn’t as highly guaranteed as a military pension, but your retirement annuity can support a “basic necessity” lifestyle. Keeping a few years’ expenses in money markets and CDs will allow you to ride out the worst of a bear market’s volatility while remaining confident that your overall portfolio has the resiliency (and the time) to recover from the inevitable financial roller-coaster.

Related articles:

Retiring on multiple streams of income
Retiring from the Reserves and National Guard
Retiring without a military pension

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About Doug Nordman

Author of "The Military Guide to Financial Independence and Retirement" and co-author of "Raising Your Money-Savvy Family For Next Generation Financial Independence."
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