The Portfolio Size Effect and Lifecycle Asset Allocation Funds: A Different Perspective

Posted: 6 Nov 2019

See all articles by Wade D. Pfau

Wade D. Pfau

The American College for Financial Services; McLean Asset Management

Date Written: August 1, 2009

Abstract

Basu and Drew (in the JPM Spring 2009 issue) argue that lifecycle asset allocation strategies are counterproductive to the retirement savings goals of typical individual investors. Because of the portfolio size effect, most portfolio growth will occur in the years just before retirement when lifecycle funds have already switched to a more conservative asset allocation. In this article, we use the same methodology as Basu and Drew, but we do not share their conclusion that the portfolio size effect soundly overturns the justification for the lifecycle asset allocation strategy. While strategies that maintain a large allocation to stocks do provide many attractive features, we aim to demonstrate that a case for supporting a lifecycle strategy can still be made with modest assumptions for risk aversion and diminishing utility from wealth. Our differing conclusion results from four factors: (1) we compare the interactions between different strategies; (2) we consider a more realistic example for the lifecycle asset allocation strategy; (3) we examine the results for 17 countries; and (4) we provide an expected utility framework to compare different strategies. We find that with a very reasonable degree of risk aversion, investors have reason to prefer the lifecycle strategy in spite of the portfolio size effect.

Keywords: lifecycle funds, target date funds, retirement planning, asset allocation, portfolio size effect

JEL Classification: D14, D81, G11, G23

Suggested Citation

Pfau, Wade D., The Portfolio Size Effect and Lifecycle Asset Allocation Funds: A Different Perspective (August 1, 2009). Journal of Portfolio Management, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1699525

Wade D. Pfau (Contact Author)

The American College for Financial Services ( email )

630 Allendale Rd
King of Prussia, PA 19406
United States

HOME PAGE: http://www.retirementresearcher.com

McLean Asset Management ( email )

1900 Gallows Rd, Suite 350
# 1150
Vienna, VA 22182
United States

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