The Cost of Diversification Over Time, and a Simple Way to Improve Target-Date Funds

56 Pages Posted: 21 Jul 2018 Last revised: 29 Jan 2020

See all articles by Haim Levy

Haim Levy

Hebrew University of Jerusalem - Jerusalem School of Business Administration; Fordham University

Moshe Levy

Hebrew University of Jerusalem - Jerusalem School of Business Administration

Date Written: July 22, 2019

Abstract

Diversification across time means changing the asset allocation from one period to another. We show that diversification across time is inferior to a portfolio with the same average asset allocation, held constant over time: it leads to a lower geometric mean, implying that in the long-run it almost-surely yields lower terminal wealth. Moreover, under mild conditions, time diversification yields a lower expected utility for all risk-averse investors and for all investment horizons. The welfare loss implied by diversification across time may be large. Target date funds help reduce the variation in the asset allocation throughout the lifecycle, by implicitly taking into account the reduction in human capital with age. However, their structure implies two systematic deviations from constant asset allocation. We suggest a simple way to correct these deviations, leading to a 10%-22% increase in welfare.

Keywords: diversification across time, diversification throughout time, lifecycle investing, target-date fund, glide-path, market timing, return chasing, stochastic dominance

JEL Classification: G11, D81

Suggested Citation

Levy, Haim and Levy, Moshe, The Cost of Diversification Over Time, and a Simple Way to Improve Target-Date Funds (July 22, 2019). Available at SSRN: https://ssrn.com/abstract=3206189 or http://dx.doi.org/10.2139/ssrn.3206189

Haim Levy

Hebrew University of Jerusalem - Jerusalem School of Business Administration ( email )

Mount Scopus
Jerusalem, 91905
Israel

HOME PAGE: http://pluto.huji.ac.il/~mshlevy/

Fordham University ( email )

140 West 62nd Street
New York, NY 10023
United States

Moshe Levy (Contact Author)

Hebrew University of Jerusalem - Jerusalem School of Business Administration ( email )

Mount Scopus
Jerusalem, 91905
Israel

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