Floor and Upside Investing in Retirement without Annuities
18 Pages Posted: 4 Oct 2014 Last revised: 24 Jan 2015
Date Written: October 2, 2014
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
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