The Impact of Investment Behavior for Individual Welfare

Abstract

The industrialized world experiences a demographic shift that is straining public pension systems. Employer-sponsored pension plans change from defined benefit to defined contribution. More emphasis is put on individually managed retirement funds. One concern with this movement is the potential negative effect on individual welfare if households’ investment behavior is suboptimal. Using micro-level U.S. data, we compare the optimal utility computed using a life-cycle model with the actual utility as reflected in empirical asset allocation choices. Average estimated welfare costs estimated are below three percent of households’ endowment (assets and human capital); yet specific population groups experience higher welfare costs.

Keywords: Asset Allocation, Investment Behavior, Welfare Costs, Life-Cycle Models

JEL Classification: D14, D91, G11