I received an e-mail from K, a 41 year old female, whose investment objective is to save for retirement. She has a moderate to high risk tolerance. 

K has a self managed portfolio invested as follows; 60% equity (5% in gold, 10% in Japanese equities, 5% in German equities, 10% US large cap value index, 10% US small cap, 20% Canadian equities, all in ETFs), 40% fixed income. She is also enrolled in a defined benefit pension plan at her work. 

She asks a two part question about asset allocation. The broader questions relates to whether her defined benefit pension plan should be included in her overall asset allocation decision. If so, should she consider her pension plan to be part of her fixed income allocation? 

At first blush the answer seems obvious. A defined benefit pension plan can represent a significant asset, and therefore, is an important part of one’s net worth statement. Just as a principal residence is an important part of one’s total net worth. But do we include those assets as part of an overall portfolio. 

Let’s look at this first from the perspective of the principal residence. Suppose an investor has a total net worth of $400,000, made up of a $200,000 portfolio and a principal residence worth $200,000. 

From the perspective of the investor’s net worth statement, adding real estate assets – i.e. real estate investment trusts – to the portfolio would be redundant. Not to mention that it would dramatically over-weight the investor’s exposure to real estate. 

On the other hand, if we are only looking at the portfolio – as opposed to the net worth statement - real estate is an excellent diversifier. It’s low correlation to equity assets effectively reduces portfolio risk. 

In short, the decision to include real estate in a portfolio hinges on whether the investor sees the principal residence as part of their long range investment plan, or simply as a place to live. If the former, then do not include real estate in the portfolio. If the latter, then build an asset mix that includes real estate, and live in your principal residence. 

The same logic can apply to the defined benefit pension. The role of the pension plan is to provide funding for K’s retirement. Which, as K tells us, is the same goal of her self managed investment portfolio. Therefore, it makes good sense to include the defined benefit pension as part of her asset allocation. Which is to say, the pension plan can be used to evaluate how K invests her personal non-registered portfolio. 

To the second part of K’s question, which is really asking whether she should increase the risk in her portfolio. O address that, we start with what we know. We know 1) K’s pension is a long term low risk portfolio, 2) K should include the pension as part of her long range investment plan and 3) the objective of K’s self managed portfolio is to fund her retirement, and 4) because K’s self managed portfolio is set up to also fund her retirement, she has a long time horizon. Perhaps as long as twenty years. 

All of these attributes support a more aggressive self-managed portfolio. Which is to say, K could raise the risk in her portfolio’s allocation, by increasing her exposure to higher risk growth oriented equity assets, and reducing her exposure to lower risk fixed income assets.

However, this thesis is predicated on the risk side of the equation. She can be aggressive because she has all of the attributes to let the portfolio grow over a long time horizon. But being able to hold a higher risk asset mix does not mean she should have a higher risk asset mix.

It really comes down to her long term objective. If as suggested, she is already comfortable with her standard of living, then she has already met her long term goal. Thanks to the defined benefit pension plan, she will enjoy the same standard of living in retirement. Which begs the question; why take risk if you do not need to take risk. 

On that basis, her current portfolio seems appropriate. Which leads me to think that she has been given advice to ramp up the risk because she can, not because she needs to. 

If, on the other hand, K is concerned that the defined pension plan will not provide the retirement lifestyle she wants, then by all means, take on additional risk in the self-managed portfolio. 

In my opinion, investors should build a more aggressive asset mix because they need to, not because they can.