Life-cycle welfare losses from rules-of-thumb asset allocation

Fabio Bagliano, Carolina Fugazza and Giovanna Nicodano

Economics Letters, 2021, vol. 198, issue C

Abstract: How should workers invest over the life-cycle? Should they follow some typical prescriptions (“rules of thumb”) in personal finance implying higher equity investments when young? We show that the answer hinges on the risk of long-term unemployment spells, entailing permanent declines in workers’ future earnings prospects. Absent unemployment risk, extant prescriptions deliver portfolios that are close to optimal, implying negligible welfare losses. They instead lead to sizeable welfare losses (3%–9% of annual consumption) when the risk of human capital depreciation following long-term unemployment is considered and realistically calibrated to the U.S. labor market. These losses stem from excess risk taking when young investors face uncertainty about future labor and pension incomes. This result points to a new design for pension plans offered by long-term institutional investors.

Keywords: Welfare; Life-cycle portfolio choice; Unemployment risk; Long term unemployment; Age rules (search for similar items in EconPapers)
JEL-codes: D15 E21 G11 (search for similar items in EconPapers)
Date: 2021
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Related works:
Working Paper: Life-Cycle Welfare Losses from Rules-of-Thumb Asset Allocation (2020)
Working Paper: Life-Cycle Welfare Losses from Rules-of-Thumb Asset Allocation (2020)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecolet:v:198:y:2021:i:c:s0165176520304158

DOI: 10.1016/j.econlet.2020.109655

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