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Tagged: financial planning

COVID-19’s Impact on Social Security

By Chris Stein M.S., CFP® | October 16, 2020

A reader would like to know about how COVID-19 will impact his Social Security benefits.

“I was planning to retire in the next twelve months. I was born in 1960, so I turned 60 this year. I plan to delay my Social Security benefit until age 70. Each year, I use Social Security’s calculator to estimate my benefit at 70 if my earnings end in 2020. The estimate has been pretty consistent for many years. I recently read an article that said because I was born in 1960, I should expect my Social Security benefit to suffer a permanent 13% reduction because of Coronavirus’s economic effects and how the Social Security benefit is calculated. It has to do with the Average Wage Index (AWI). Is this really possible, and is it actually going to happen? How you would adjust the estimated Social Security benefit for a client that turns 60 this year. Should I just lop off 13% from my calculations?”

Anyone born in 1960 is probably listening very closely. And I don’t blame you.

You asked if COVID-19 could cause a reduction in Social Security benefits. Yes, it can because of the way those benefits are calculated. Those calculations use your Average Indexed Monthly Earnings (AIME). AIME attempts to approximate a lifetime of earnings using today’s wage levels as a benchmark.

By “indexed,” we mean adjusted for inflation, specifically wage inflation, not price inflation. The Cost of Living Adjustments (COLAs) that Social Security beneficiaries get most years are based on prices: the Consumer Price Index or CPI. A lot of people mix those two up.

The AIME calculation indexes your past earnings and adjusts them for wage inflation. It ensures that your benefit accruals keep up with inflation and general pay increases during your working life. For wage inflation, they use the Average Wage Index (AWI). They take all of the people who filed W-2s for income from a job at any time in one year (say 2020). That gives them the total number of wage-earners. Then they take the total amount of wages that were paid that year, and they calculate the average wage for 2020. They’ve done the same for 2019, 2018, and back to when they started doing this.

The wage inflation statistic is used to adjust all of your earnings. It also adjusts the “bend points” used in calculating your Primary Insurance Amount (PIA). We’ve gone into great detail elsewhere on how Social Security benefits are calculated. But, briefly, bend points are where you have replaced 90%, 32% or 15% of different portions of your AIME.

For this discussion, to understand how someone’s benefits could be vulnerable, if there is an AWI decline – negative growth in wages for 2020 – that will affect your AMIE calculation, which, in turn, will also affect your PIA.

Some of the calculations I’ve seen are predicting a 13% permanent reduction. So, you’re thinking, why is this only happening to people born in 1960?

First, it’s a one-year blip called a “notch” year, something unique that happens one year that affects only people born in one (or two) years. People born afterward will likely not feel a permanent impact because wages are likely to bounce back in subsequent years (2021, 2022 and 2023, for example), and the increase will compensate for the short-term loss. If you were born before 1960 or after 1960, you wouldn’t notice the event because the impact gets smoothed out.

But 1960 is going to take a permanent hit. And why is it permanent? Because in 2020, people born in 1960 are 60 years old. That’s the last year of your wages that are indexed for inflation. So, depending on if you are retired, any wages you may or may not have next year (when you’re 61) will not be adjusted. That means the bounce-back that you might have gotten– that the economy might see in wages in 2021 – you will not get if you were born in 1960.

I am not as concerned as those waving big red flags on the internet to get you to click and read their articles. That’s because Congress hasn’t weighed in on this – and they can fix this. There are lots of things they could do.

For example, Congress can cause a single-year adjustment to how the wage index adjustment is calculated. They can also have Social Security ignore the wage index adjustment for 2020, calling it an anomaly. Or Congress could say, “Let’s calculate the AWI for 2020 based only on the first quarter. Just look at January, February and March.” That would solve this essentially.

This issue is getting more and more attention, so, hopefully, some conversations are happening on Capitol Hill to solve it. The real consumer protection advocates are likely bouncing around some ideas about how to avoid this.

I’d put this issue in the “unfair” category because it’s merely due to how a calculation is made. But it’s not the first time. Something similar happened in 2008-2009, but the impact was only 1.51%, so no action was taken.

[FYI: Source for 2009 stat: https://www.forbes.com/sites/ebauer/2020/06/24/social-security-explainer-how-are-average-wages-calculatedand-how-that-affects-your-benefits/#56b69f164752]

But here’s why 2020 is such an issue. As we said, the calculation totals up all employment income reported for the year and divides it by all the workers who worked at some point during the year. The number of people working in early 2020 was high; each person will get a W-2 and be counted as workers. If they only worked in the first quarter, though, their wages for the year will be super low.

So, the numerator (the total wages paid in the economy) will be a lot lower than usual. Yet the denominator (the ‘divided by’ number of workers) is still going to be full-sized. And the Social Security calculation was never designed to accommodate something like this. That’s the fundamental issue.

Why do I think Congress will step in? Because a lot of people were born in 1960 – in fact, about 4.25 million. And this situation is genuinely unfair to them specifically and represents significant financial harm. I don’t have a crystal ball, but we’ve seen Washington make some pandemic-related allowances recently in situations that were far less unfair.

[FYI: Source for population: https://www.infoplease.com/us/population/live-births-and-birth-rates-year]

Enough complaints from constituents would make a difference. Start writing to your congresspeople now: Senators and House Representatives. Say, “Hey, take care of this.” Or call them. Get your friends and family to call them, too. Put pressure on them to fix it.

There is often action on Capitol Hill that we don’t hear about while it’s in process. We are monitoring the situation closely. If we learn of anything new, we will bring it up immediately.

Why Investor Returns Usually Fall Short of Benchmarks

By Scott Roark, MBA, PhD | July 17, 2020

In podcast episodes and in past blog posts (10/25/2019, 4/20/2019) we’ve talked about the importance of benchmarking – comparing the investment performance on a risk-adjusted basis to an objective measure.

At Jim Saulnier & Associates, we use five Morningstar benchmarks that are adjusted based on risk tolerance.  The benchmarks are for Conservative portfolios (20% equity, 80% fixed income), Conservative Growth portfolios (40% equity, 60% fixed income), Moderate portfolios (60% equity, 40% fixed income), Moderately Aggressive portfolios (80% equity, 20% fixed income) and Aggressive portfolios (95% equity, 5% fixed income).  The Morningstar benchmarks we use consist of around 15-18 individual holdings that are a mix of domestic equity, international equity, large cap, small cap, mid-cap, long-term bond, intermediate bond, short term bond, international bonds, REITs, TIPs, etc.

We have designed our five “Convenience” portfolios to mimic these Morningstar benchmarks.  Jim has repeatedly stated in podcast episodes and in meetings with clients that we do not expect to beat the benchmark, but instead we fully expect to trail the benchmark to at least a certain extent. The reason is that there are several factors that act as a “headwind” for the investor and can mean their performance will not match the performance of the benchmark.  Below is a discussion of the biggest factors.  While this list is not an exhaustive list of everything that can hinder performance, it will touch on the main reasons that an investor might not see the same returns as the benchmark returns they are tracking.


The most obvious reason that an investment generally lags a benchmark is the fees involved.  These would include, but not necessarily be limited to, fees on the mutual fund or ETF that is used, fees from an investment advisor, fees paid to a broker-dealer and brokerage wrap fees.  A quick example with worst case numbers will quickly show why performance might lag a benchmark by quite a bit.

Assume that you have a relationship with a financial advisor that charges an Assets Under Management (AUM) fee of 0.75% per year.  This advisor outsources investment management to a 3rd party who creates a portfolio that is consistent with the risk tolerance of the client.  This investment manager would also charge a fee – let’s assume 0.40% per year.  Finally, there are likely fees in the mutual funds or ETFs held in the investment account.  Let’s assume that the funds are actively managed funds and that the fund fees are close to the average for large-cap stock funds and are equal to 0.85% per year.  All together these fees add up to 2.0%.  This means that if the investments earned 6.0%, you netted only 4.0% after paying the fees.  Even if the investment choices were perfectly aligned with the benchmark, you as an investor would trail the benchmark by 2% per year because of these fees.


Even if fees were not part of the equation (there are funds and ETFs available now that are 0% fee index funds), there are still reasons your performance may trail a benchmark.  The timing of the investment additions or cash withdrawals will affect the performance.  If you are dollar cost averaging and making additions to your investments each month, then the part of returns that occur later in the year have a bigger impact then the part of returns that occur earlier in the year.  The reason is that you have more money in your account being affected by the return.  Say the return for January is -3% and the return for December is +3%.  If you have been adding money along the way, you will have more invested by the time December comes around and it will help your “dollar-weighted” performance.

On the other hand, if you are in retirement and making consistent withdrawals then the sooner bad returns happen, the worse it is for you.  This is the whole idea behind sequence of return risk (see 08/02/2019 blog post).

Regardless of whether you are adding money or withdrawing it, the simple fact that you have cash flows coming in or going out will cause the returns you experience in your account to be different from the benchmark which assumes that the only additions would be from reinvested dividends or interest.

Investment Composition

A third reason your returns might not match a benchmark is that the particular investments you have don’t exactly match what is in the benchmark.  This might easily happen if a large-cap fund manager for an actively traded fund has different sector weights than the S&P 500 index (which we’ll assume is the appropriate benchmark).  Perhaps she even holds the same 500 stocks as the S&P 500 index.  She just holds them in different proportions than the index.  If she is “overweight” the good performers, her fund will outperform the benchmark (assuming her fees don’t eat up all the difference!).  On the other hand, she might have decided to be overweight in the sectors that are lagging and her fund performance will be worse than the index.  The difference that is there is the result of differences in the individual holdings in the fund compared to its benchmark.

This might also happen if one is comparing the performance for a conservative allocation fund to a conservative benchmark (like the Morningstar Conservative model portfolio).  Perhaps the conservative allocation fund manager has decided to be 24% equity and 76% fixed income as compared to the 20% equity, 80% fixed income in the benchmark.  In this case, if equities outperform fixed income, this fund will do better than its benchmark.  It will have a different composition, it will entail more risk, but it will compare favorably to its benchmark.


Yet another reason that investment performance in your account might be different from its benchmark is due to rebalancing.  Typically, a benchmark will involve systematic rebalancing to determine performance.  For the Morningstar portfolio benchmarks that we use the rebalancing occurs on a monthly basis.  If a particular investor’s account isn’t rebalanced on the same schedule, this could again create differences in performance over the course of a year.


The final reason I’ll mention in this post relates to taxes.  This is more of a stealthy reason for performance difference because taxes are rarely if ever paid out directly from the investment account.  However, if there are dividend payments or interest income or capital gains distributions that occur in a taxable account, there will be an increase in the tax amount an investor pays because of these gains.  This is effectively reducing the performance of the account compared to its benchmark where the returns reported are not affected by taxation.

For all the reasons listed, and probably a few more that aren’t listed, it is unlikely that your investment performance will match the performance of the benchmark you have chosen.  But it is important that you understand how big the difference is and what is causing the differences.  Are you being killed by fees?  Is your investment selection very different from your benchmark?

The goal at the end of the day is that your performance over time is close to and perhaps slightly lower than the performance of the benchmark.  However, ideally you would see a very high correlation between your performance and the benchmark’s performance.  That will mean that you have invested in a way consistent with your goals.