Asset Market Participation and Portfolio Choice over the Life-Cycle

Models of life cycle portfolio decisions with labor income uniformly predict that investors should reduce their portfolio share in stocks as they age because human capital, which acts a bond, becomes a smaller component of household total wealth. Despite the fact that the prediction rests on an undisputed fact - the shrinking pattern of human wealth over the life cycle - it has not yet found empirical support. We study the life cycle portfolio allocation using a random sample of 75,000 households drawn from the Norwegian Tax Registry followed over 14 years which contains exhaustive and error-free information on all components of households’ investments. We find that both participation in the stock market and the portfolio share in stocks have important life cycle patterns. Participation is limited at all ages but follows a hump-shaped profile which peaks around retirement; as households retire and begin decumulating wealth, they start exiting the stock market. The share invested in stocks among the participants is high and flat for the young but investors start reducing it slowly as retirement age gets closer. Our data suggest a double adjustment as people age: a rebalancing of the portfolio away from stocks as they approach retirement, and stock market exit after retirement. Existing calibrated life cycle models can account for the first behavior but not the second. We show that extending the models in Gomes, Kotlikoff, and Viceira (2008) and Gomes and Michaelides (2003) to incorporate reasonable per period participation costs can generate a joint pattern of participation and the risky asset share over the life cycle similar to the one observed in the data. In addition, if we add a small perceived probability of being cheated when investing in stocks, the model predicts a share in stocks much closer to the one observed in the data.