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Optimal Asset Allocation in Retirement: A Downside Risk Perspective

July 14, 2011 Comments off

Optimal Asset Allocation in Retirement: A Downside Risk Perspective (PDF)
Source: Putnam Institute

Once an individual has retired, asset allocation becomes a critical investment decision. Unfortunately, there is no consensus on what the optimal allocation should be for retirees of varying age, gender, and risk tolerance. This study analyzes the allocation question through a focus on the downside risks created by uncertainty over investment returns and life expectancy. We find that the range of appropriate equity asset allocations in retirement is strikingly low compared with those of typical lifecycle and retirement funds now in the marketplace. In fact, for retirement portfolios whose primary goal is to minimize the risk of depletion and sustain withdrawals, optimal equity allocations range between 5% and 25%. This quite conservative level of equity holdings changes little even when we significantly change our assumptions on capital market returns. We even find that more aggressive equity allocations, those that still retain some focus on depletion risk but also seek to provide substantial bequests to heirs, are also relatively conservative. The study suggests, in short, that the higher equity allocations used in many popular retirement investment products today significantly underestimate the risks that these higher-volatility portfolios pose to the sustainability of retirees’ savings and to the incomes they depend on.

Hat tip: PW

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