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Money in Motion: Dynamic Portfolio Choice in Retirement

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Author Info
Wolfram J. Horneff
Raimond H. Maurer
Olivia S. Mitchell
Michael Z. Stamos

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Abstract

Retirees confront the difficult problem of how to manage their money in retirement so as to not outlive their funds while continuing to invest in capital markets. We posit a dynamic utility maximizer who makes both asset location and allocation decisions when managing her retirement financial wealth and annuities, and we prove that she can benefit from both the equity premium and longevity insurance in her retirement portfolio. Even without bequests, she will not fully annuitize; rather, her optimal stock allocation amounts initially to more than half of her financial wealth and declines with age. Welfare gains from this strategy can amount to 40 percent of financial wealth (depending on risk parameters and other resources). In practice, it turns out that many retirees will do almost as well by purchasing a variable annuity invested 60/40 in stocks/bonds.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 12942.

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Date of creation: Feb 2007
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Handle: RePEc:nbr:nberwo:12942

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Find related papers by JEL classification:
D14 - Microeconomics - - Household Behavior - - - Personal Finance
G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies
G23 - Financial Economics - - Financial Institutions and Services - - - Pension Funds; Other Private Financial Institutions
H55 - Public Economics - - National Government Expenditures and Related Policies - - - Social Security and Public Pensions
J26 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Retirement; Retirement Policies

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  1. Martin Feldstein & Elena Ranguelova, 2001. "Individual Risk in an Investment-Based Social Security System," NBER Working Papers 8074, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  2. Charupat, Narat & Milevsky, Moshe A., 2002. "Optimal asset allocation in life annuities: a note," Insurance: Mathematics and Economics, Elsevier, vol. 30(2), pages 199-209, April. [Downloadable!] (restricted)
  3. Wolfram Horneff & Raimond Maurer & Olivia Mitchell & Ivica Dus, 2006. "Optimizing the Retirement Portfolio: Asset Allocation, Annuitization, and Risk Aversion," Working Papers wp124, University of Michigan, Michigan Retirement Research Center. [Downloadable!]
    Other versions:
  4. Blake, David & Cairns, Andrew J. G. & Dowd, Kevin, 2003. "Pensionmetrics 2: stochastic pension plan design during the distribution phase," Insurance: Mathematics and Economics, Elsevier, vol. 33(1), pages 29-47, August. [Downloadable!] (restricted)
  5. Wolfram Horneff & Raimond Maurer & Michael Stamos, 2006. "Life-Cycle Asset Allocation with Annuity Markets: Is Longevity Insurance a Good Deal?," Working Papers wp146, University of Michigan, Michigan Retirement Research Center. [Downloadable!]
  6. 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)
  7. Ivica Dus & Raimond Maurer & Olivia S. Mitchell, 2003. "Betting on Death and Capital Markets in Retirement: A Shortfall Risk Analysis of Life Annuities versus Phased Withdrawal Plans," Working Papers wp063, University of Michigan, Michigan Retirement Research Center. [Downloadable!]
  8. Gerrard, Russell & Haberman, Steven & Vigna, Elena, 2004. "Optimal investment choices post-retirement in a defined contribution pension scheme," Insurance: Mathematics and Economics, Elsevier, vol. 35(2), pages 321-342, October. [Downloadable!] (restricted)
  9. Zvi Bodie & James E. Pesando, 1986. "Retirement Annuity Design in an Inflationary Climate," NBER Working Papers 0896, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  10. Koijen, Ralph S.J. & Nijman, Theo E. & Werker, Bas J.M., 2006. "Optimal portfolio choice with annuitization," Discussion Paper 78, Tilburg University, Center for Economic Research. [Downloadable!]
  11. John F. Cogan & Olivia S. Mitchell, 2003. "Perspectives from the President's Commission on Social Security Reform," Journal of Economic Perspectives, American Economic Association, vol. 17(2), pages 149-172, Spring. [Downloadable!] (restricted)
  12. Kingston, Geoffrey & Thorp, Susan, 2005. "Annuitization and asset allocation with HARA utility," Journal of Pension Economics and Finance, Cambridge University Press, vol. 4(03), pages 225-248, October. [Downloadable!]
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  13. Thomas Davidoff & Jeffrey R. Brown & Peter A. Diamond, 2005. "Annuities and Individual Welfare," American Economic Review, American Economic Association, vol. 95(5), pages 1573-1590, December. [Downloadable!] (restricted)
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  1. Wolfram J. Horneff & Raimond H. Maurer & Olivia S. Mitchell & Michael Z. Stamos, 2008. "Asset Allocation and Location over the Life Cycle with Survival-Contingent Payouts," NBER Working Papers 14055, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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