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Precautionary savings motives and tax efficiency of household portfolios: an empirical analysis

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Author Info
Gene Amromin
Abstract

Tax efficiency is the dominant consideration in theoretical portfolio models that allow for both taxable and tax-deferred accounts (TDAs). Investors are advised to locate higher-tax assets in their tax-deferred accounts, which in the Unites States commonly translates into "holding bonds inside TDAs and holding equities outside." Yet, observed portfolio allocations are not tax efficient. This paper empirically evaluates the predictions of a recent model designed to bridge the existing gap by explicitly incorporating uninsurable labor income risk and limited accessibility of TDA assets in household decisions [Amromin, 2003]. Together, these elements create tension between household's desire to maintain tax efficient allocations and its concern over the need to make costly TDA withdrawals in the event of bad income draws. This leads some borrowing-constrained households facing labor income risk and TDA access penalties to forgo tax efficiency in favor of allocations that provide more liquidity in bad income states--an outcome labeled as "precautionary portfolio choice." The empirical results based on household-level portfolio data from the Survey of Consumer Finances provide evidence that both the choice of whether to hold a tax efficient portfolio and the degree of portfolio tax inefficiency are related to the presence and severity of precautionary motives.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2005-01.

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Date of creation: 2005
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Handle: RePEc:fip:fedgfe:2005-01

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Keywords: Households - Economic aspects ; Saving and investment;

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References listed on IDEAS
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  5. Karen M. Pence, 2002. "401(k)s and household saving: new evidence from the Survey of Consumer Finances," Finance and Economics Discussion Series 2002-6, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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  8. Guiso, Luigi & Jappelli, Tullio & Terlizzese, Daniele, 1992. "Earnings uncertainty and precautionary saving," Journal of Monetary Economics, Elsevier, vol. 30(2), pages 307-337, November. [Downloadable!] (restricted)
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  9. Christopher D. Carroll & Karen E. Dynan & Spencer D. Krane, 2003. "Unemployment Risk and Precautionary Wealth: Evidence from Households' Balance Sheets," The Review of Economics and Statistics, MIT Press, vol. 85(3), pages 586-604, 05. [Downloadable!] (restricted)
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  10. Annette Vissing-Jorgensen, 2002. "Towards an Explanation of Household Portfolio Choice Heterogeneity: Nonfinancial Income and Participation Cost Structures," NBER Working Papers 8884, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  12. Kimball, Miles S, 1993. "Standard Risk Aversion," Econometrica, Econometric Society, vol. 61(3), pages 589-611, May. [Downloadable!] (restricted)
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  13. Joao F. Cocco, 2005. "Consumption and Portfolio Choice over the Life Cycle," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 18(2), pages 491-533. [Downloadable!] (restricted)
  14. Heaton, John & Lucas, Deborah, 2000. "Portfolio Choice in the Presence of Background Risk," Economic Journal, Royal Economic Society, vol. 110(460), pages 1-26, January. [Downloadable!] (restricted)
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  16. Kimball, Miles S, 1990. "Precautionary Saving in the Small and in the Large," Econometrica, Econometric Society, vol. 58(1), pages 53-73, January. [Downloadable!] (restricted)
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  17. Heaton, John & Lucas, Deborah, 1997. "Market Frictions, Savings Behavior, And Portfolio Choice," Macroeconomic Dynamics, Cambridge University Press, vol. 1(01), pages 76-101, January. [Downloadable!]
  18. James Banks & Richard Blundell & James P. Smith, 2002. "Wealth Portfolios in the UK and the US," NBER Working Papers 9128, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  19. Christopher D. Carroll & Andrew A. Samwick, 1998. "How Important Is Precautionary Saving?," The Review of Economics and Statistics, MIT Press, vol. 80(3), pages 410-419, August. [Downloadable!] (restricted)
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  20. James M. Poterba & John B. Shoven & Clemens Sialm, 2000. "Asset Location for Retirement Savers," NBER Working Papers 7991, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  21. James M. Poterba & Andrew A. Samwick, 1997. "Household Portfolio Allocation Over the Life Cycle," NBER Working Papers 6185, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  22. Luis M. Viceira, 1999. "Optimal Portfolio Choice for Long-Horizon Investors with Nontradable Labor Income," NBER Working Papers 7409, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  23. repec:cup:macdyn:v:1:y:1997:i:1:p:76-101 is not listed on IDEAS
  24. Gene Amromin, 2003. "Household Portfolio Choices in Taxable and Tax-Deferred Accounts: Another Puzzle?," Review of Finance, Springer, vol. 7(3), pages 547-582. [Downloadable!]
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    Other versions:
  26. Nellie Liang & Scott Weisbenner, 2002. "Investor Behavior and the Purchase of Company Stock in 401(k) Plans - The Importance of Plan Design," NBER Working Papers 9131, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  27. Amemiya, Takeshi, 1979. "The Estimation of a Simultaneous-Equation Tobit Model," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 20(1), pages 169-81, February. [Downloadable!] (restricted)
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