Optimizing the Retirement Portfolio: Asset Allocation, Annuitization, and Risk Aversion

Wolfram Horneff, Raimond Maurer, Olivia Mitchell and Ivica Dus ()
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Wolfram Horneff: Johann Wolfgang Goethe-University of Frankfort
Raimond Maurer: Johann Wolfgang Goethe-University of Frankfort

Working Papers from University of Michigan, Michigan Retirement Research Center

Abstract: Retirees must draw down their accumulated assets in an orderly fashion so as not to exhaust their funds too soon. We derive the optimal retirement portfolio from a menu that includes payout annuities as well as an investment allocation and a withdrawal strategy, assuming risk aversion, stochastic capital markets, and uncertain lifetimes. The resulting portfolio allocation, when fixed as of retirement, is then compared to phased withdrawal strategies such a "self-annuitization" plan or the 401(k) 'default' pattern encouraged under US tax law. Surprisingly, the fixed percentage approach proves appealing for retirees across a wide range of risk preferences, supporting financial planning advisors who often recommend this rule. We then permit the retiree to switch to an annuity later, which gives her the chance to invest in the capital market and "bet on death." As risk aversion rises, annuities first crowd out bonds in retiree portfolios; at higher risk aversion still, annuities replace equities in the portfolio. Making annuitization compulsory can also lead to substantial utility losses for less risk-averse investors.

New Economics Papers: this item is included in nep-upt
Date: 2006-07
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Working Paper: Optimizing the Retirement Portfolio: Asset Allocation, Annuitization, and Risk Aversion (2006)
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