Floor and Upside Investing in Retirement without Annuities

Abstract

I investigate optimal stock/bond asset allocation and consumption decisions using a utility function that is intended to be representative of a retired individual's need for an income floor and desire for upside potential. I do this without using annuities. Breaking with a common assumption that you should become more conservative if you have reached “your number,” the asset allocation to stocks increases if floor consumption is largely satisfied. I discover a bond heavy region that absorbs the impact of downside stock market shocks and protect the income floor. I also discover declining absolute bond holdings when downside risks are small. Careful tuning of the parameters of the aggregate utility function makes it possible to engineer the asset allocation/consumption strategy to meet the retired individual's specific income goals while keeping the consumption floor covered.

Keywords: asset allocation, consumption, stochastic dynamic programming