Life-Cycle Welfare Losses from Rules-of-Thumb Asset Allocation

Fabio Bagliano, Carolina Fugazza (carolina.fugazza@unito.it) and Giovanna Nicodano
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Carolina Fugazza: Department of Economics and Statistics (Dipartimento di Scienze Economico-Sociali e Matematico-Statistiche), University of Torino, Italy

No 68, Working papers from Department of Economics, Social Studies, Applied Mathematics and Statistics (Dipartimento di Scienze Economico-Sociali e Matematico-Statistiche), University of Torino

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 sizable 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)
Pages: 24 pages
Date: 2020-09
New Economics Papers: this item is included in nep-dge and nep-rmg
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https://www.bemservizi.unito.it/repec/tur/wpapnw/m68.pdf First version, 2020 (application/pdf)

Related works:
Journal Article: Life-cycle welfare losses from rules-of-thumb asset allocation (2021)
Working Paper: Life-Cycle Welfare Losses from Rules-of-Thumb Asset Allocation (2020)
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