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

Posted: 19 Feb 2008

See all articles by Wolfram J. Horneff

Wolfram J. Horneff

Deka Investment

Raimond Maurer

Goethe University Frankfurt - Finance Department

Olivia S. Mitchell

University of Pennsylvania - The Wharton School; University of Pennsylvania - The Wharton School, Pension Research Council; National Bureau of Economic Research (NBER)

Ivica Dus

University of Frankfurt

Multiple version iconThere are 3 versions of this paper

Date Written: July 2006

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.

Suggested Citation

Horneff, Wolfram J. and Maurer, Raimond and Mitchell, Olivia S. and Dus, Ivica, Optimizing the Retirement Portfolio: Asset Allocation, Annuitization, and Risk Aversion (July 2006). Michigan Retirement Research Center Research Paper No. WP 2006-124, Available at SSRN: https://ssrn.com/abstract=1094991

Wolfram J. Horneff (Contact Author)

Deka Investment ( email )

Hans-Bethe-Str. 11
Frankfurt, 60438
Germany
004915152529967 (Phone)

Raimond Maurer

Goethe University Frankfurt - Finance Department ( email )

Theodor-W.-Adorno-Platz 3
House of Finance
Frankfurt, 60323
Germany

Olivia S. Mitchell

University of Pennsylvania - The Wharton School ( email )

Philadelphia, PA 19104-6365
United States

University of Pennsylvania - The Wharton School, Pension Research Council ( email )

3302 Steinberg Hall-Dietrich Hall
3620 Locust Walk
Philadelphia, PA 19104-6302
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Ivica Dus

University of Frankfurt ( email )

Grüneburgplatz 1
Frankfurt am Main, 60323
Germany

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